Co-Authored by Erin Fonte and Brenna McGee
As an eventful 2018 comes to a close, we look ahead to 2019 and our “Top 10 List” of key issues U.S. financial institutions, non-banks providing financial services, and financial technology (fintech) entities should plan for and watch throughout the upcoming year. The first five items on the list are discussed below, and the remainder of our list will follow shortly in another post.
We will start the list with a couple of topics from “over the pond” that will have a continuing impact on U.S. financial services entities. The British Parliament was scheduled to vote on Tuesday on the agreement that Prime Minister Theresa May reached with the European Union (EU) for Britain’s departure from the EU, commonly referred to as “Brexit.” But in an unscheduled address to Parliament on Monday, May said that she would seek to postpone the parliamentary vote, noting that if the vote were to be held as planned, her proposal “would be defeated by a significant margin.” As a result, May’s own party triggered a no-confidence vote on May that would have seen her removed as Prime Minister if she lost. By a vote of 200 to 117, May won a vote of confidence in her leadership and is now immune from a leadership challenge for a year.
What will happen next regarding Brexit is even less clear. There are a range of possibilities, including moving ahead with a vote on the current plan, a snap general election, and a second popular referendum on whether to leave the EU. Providing a boost to those seeking a second Brexit vote, on Monday morning the EU’s highest court ruled that Britain could unilaterally reverse its decision to leave the EU any time before the March 29th. One option that everyone agrees must be avoided is a no-deal Brexit, which could cause chaos at the borders, businesses to lose their passporting rights, and even planes to be grounded.
While financial institutions in the UK and EU obviously will bear the brunt of Brexit, banks and fintechs in the U.S. will also feel the effects. Many large U.S. banks and fintechs use London as the gateway to other European markets, so the potential loss of passporting is particularly significant. The EU passporting system enables banks and financial services companies that are authorized in any EU state to trade freely in any other with minimal additional authorization. After Brexit, all UK-based businesses will be outside the EU and face significant regulatory barriers to providing cross-border financial services to customers in the EU. For U.S. banks and fintechs without a direct European presence, but with correspondent banking and vendor relationships in the UK and EU, those relationships will require close monitoring and potentially even restructuring, depending on how Brexit actually occurs.
More generally, if the Brexit process is further prolonged or the UK moves forward with a no-deal Brexit, it may fuel global economic uncertainty and weaken financial markets. After May announced she was postponing the Brexit vote, the Dow fell as much as 500 points and the British pound extended its losses, plunging 1.6% against the US dollar. Merger and acquisition activity may also suffer as the probability of deal announcements, particularly in Europe, might witness a slowdown and affect banks’ earnings in 2019. Earnings for U.S. banks, even those solely focused on the domestic market, could be negative and the potential weakening of global growth could cause domestic loan demand to sputter. While what will happen next with Brexit is unknown, banks and fintechs should prepare themselves now for the worst case scenario of a no-deal UK break from the EU and start with contingency planning. March 29, 2019 is rapidly approaching.
2. EU PSD2/Open Banking
The EU Revised Payment Services Directive, or PSD2, was initially passed by the Council of the European Union on November 16, 2015, and EU member countries were given until January 2018 to enact country-specific transposing legislation. As of the date of this blog post, all EU member countries had met this deadline except for the Netherlands and Romania. Companies operating in the EU have until September 2019 to comply with applicable EU member country laws.
PSD2 amended the original EU Payment Services Directive to (1) add “market rules” to describe which type of organizations can provide payment services, and include a new category of “payment institution” to augment the already-existing categories of “credit institution” (e.g. banks) and “electronic money institution” (e.g. money transmitters), and (2) add “business conduct rules” to define the transparency that information payment service institutions need to provide, such as any charges, exchange rates, transaction references and maximum execution time.
PSD2 is expansive and includes numerous updates, but the PSD2 requirement for financial institutions to participate in an “open banking” system is arguably the most controversial and potentially disruptive component. PSD2 stipulates that banks must provide open application programming interfaces (APIs), which grant developers with programmatic access to previously proprietary technology. Additionally, banks are also required to share banking data with third parties (with bank customers’ permission) like “payment institutions” providing a product or service to that same customer.
As companies move toward the September 2019 compliance deadline, there is the potential for new or enhanced products and services built upon the open API capabilities. The regulation lays groundwork for an entirely open banking system that encourages collaboration over competition—and that many predict will be a catalyst for major fintech advances and innovations across Europe.
While banks originally raised concerns with the open banking mandate under PSD2, the 10th Annual Temenos Survey reports eight in 10 bankers see open banking as more of an opportunity than a threat, and 62 percent say that they’re prepared to distribute third-party products through their own platforms and channels. Considering that new technology can bring new products and services to a bank’s core customers—which in turn generates additional revenue opportunities for financial institutions—banks’ now widespread acceptance of the new system under PSD2 makes sense even given initial concern or opposition.
In pursuit of these new potential revenue streams, many EU operating banks are actively adopting advanced technology and engaging fintech companies in partnerships to provide their customers with the latest innovations. Banks in the EU are also increasingly providing seed money for fintech startups’ development—and even eventually acquiring these newer companies. These activities are representative of an industry-wide acknowledgement of how new tech benefits stand to positively impact banking and financial services on a global scale.
The U.S. financial services industry is observing the PSD2 rollout in Europe, along with open banking initiatives taking place across Asia, with great interest. Both a CFPB “Principles For Consumer-Authorized Financial Data Sharing and Aggregation” (released October 18, 2017) and the U.S. Department of Treasury fintech report released July 31, 2018, make mention of more open and secure access to financial institution customer data, but both reports essentially left the private marketplace to sort out that issue, in sharp contrast to what is going on from a regulatory top-down direction in the EU. As foreign banks, third-party fintech providers and customers begin to develop and streamline processes and procedures to operate within a fully open global banking system, they are simultaneously building out a skeleton framework for the US to base its own open banking standard practices on in the near future. Pay attention in 2019 to the ripple effects of open banking that make their way across the pond to the U.S.
3. Ongoing Changes at the CFPB
After a turbulent year at the Consumer Financial Protection Bureau (CFPB) that saw Richard Cordray abruptly resign as Director, Mick Mulvaney and Leandra English head to court to determine who was the rightful Acting Director, and significantly curtailed CFPB enforcement activity, the CFPB is poised for a less eventful 2019. On December 6, 2018, Kathy Kraninger was confirmed as the new Director of the CFPB for a 5-year term, giving the Agency the stability it has lacked for the last 13 months.
Most industry experts expect Kraninger to continue with Mulvaney’s “business-friendly” transformation of the CFPB. While acting director, Mulvaney scaled back enforcement actions, dropped some lawsuits and moved to reconsider rules criticized by the financial industry. But in a briefing with reporters at the CFPB’s Washington headquarters on Tuesday, Kraninger said that she would not merely be following in the footsteps of her immediate predecessor. “I will be fully accountable for the decisions I make going forward, and they will be mine,” she said.
One way that Kraninger may immediately break with Mulvaney is on the name of the Agency. Mulvaney launched an effort to change the bureau’s name to the Bureau of Consumer Financial Protection, or BFCP, in April 2018, stating that the new name better reflected the name of the agency as set out in Dodd-Frank, the statute that established the agency. However, The Hill reported this month that the change could cost the agency between $9 and $19 million to change, and the companies that the CFPB regulates more than $300 million. On Tuesday Kraninger said she understood why Mulvaney wanted to make the change but noted that its original title resonates with employees. A decision on the future of the name could be made soon, she said. “I care more about what the agency does than what it is called,” she said. (This also explains why we are sticking with “CFPB” for purposes of this post.)
4. Congressional Changes
In the 2018 midterm elections, the Democrats captured a majority in the House of Representatives, while Republicans expanded their Senate majority by two seats. Bankers that have been hoping for more regulatory relief are likely out of luck until 2020. During the first Financial Services Committee hearing since the election, Representative Maxine Waters (D-CA) who will become chair in January 2019, announced that deregulation efforts are finished. “Make no mistake,” she said. “Come January, the days of this committee weakening regulations and putting our economy once again at risk of another financial crisis will come to an end.”
Although a significant shift in legislative efforts relating to the financial services industry is expected during 2019, Congress is most likely to face legislative gridlock because Democrats only control the House. As such, bankers are not likely to see new banking legislation on the President’s desk.
What Democratic committee chairs in the House will have, though, is virtually unchecked investigatory power to issue subpoenas, demand documents, call hearings and compel witnesses to testify. Waters said in a recent interview that an investigation into President Donald Trump’s personal financial dealings with Deutsche Bank is just one of several issues the House Financial Services Committee has on its plate. But she added, “We have the power to deal with subpoenas, but I want you to know we’re not just focused on that alone.” Waters also said that the committee will be focused on housing policies and the CFPB, which she called one of “the most important centerpieces” of the post-recession reforms.
On the Senate side, with a larger majority, Republicans expect to have their own mechanism to reshape the financial services industry by confirming new leadership of financial regulatory bodies. Pending nominations include Nellie Liang and Marvin Goodfriend to serve on the Board of Governors of the Federal Reserve. The President has had the chance in his first two years in office to make selections for six of the Fed’s seven seats. In addition, the term of Obama-appointed Federal Housing Finance Agency Director Mel Watt expires at the end of 2018. According to reports, the White House is preparing to pick Mark Calabria, a vice presidential aide and outspoken critic of Fannie Mae and Freddie Mac, to the post responsible for overseeing the powerful housing-finance companies. Fannie Mae and Freddie Mac are at the heart of the nation’s mortgage-financing system, and the FHFA director is responsible for overseeing their massive $5.4 trillion portfolio. The companies have been in conservatorship since 2008, when Treasury seized control of them to prevent their collapse during the housing crisis.
5. States’ Role in Consumer Protection
With the CFPB taking a step back from its role as the nation’s consumer protection watchdog, states have stepped up their consumer financial protection activity. State attorneys general have the power to enforce not only the many state laws and regulations that apply to financial companies but also federal ones. For example, Section 1042 of the Dodd-Frank Act (codified at 12 U.S.C. § 5552) allows state attorneys general to bring actions to enforce provisions of the Dodd-Frank Act, and CFPB regulations issued under it, against financial services entities. This includes the authority to pursue actions for “abusive” acts or practices against state-chartered banks and nonbank entities.
Although there has perhaps not been as much activity by states as some had expected, states are coordinating on enforcement actions. On December 4, the North Carolina Attorney General, along with 41 other state attorneys general, announced a $6 million settlement with one of the nation’s largest debt buyers. According to the press release, the debt buyers engaged in robo-signing practices by signing and filing large quantities of affidavits in state courts without first verifying the provided information. The settlement resolves allegations concerning the debt buyers’ collection and litigation practices, and will permanently bar the debt buyers from engaging in the prohibited practices moving forward.
Watch for state regulation and enforcement in the student loan industry. The CFPB and the Department of Education have curtailed their student loan work, and Secretary of Education Betsy DeVos has specifically worked to shield student loan companies from state consumer protection laws. In response, Seth Frotman, the CFPB’s former student loan ombudsman who resigned in protest earlier this year, has launched a new nonprofit, The Student Borrower Protection Center, to tackle the nation’s student loan problem. Frotman said that goal of the new organization is to provide “deep subject matter expertise” to state legislators, attorneys general, nonprofit organizations, legal aid attorneys and others to take on companies preying on borrowers.
Make sure to check the NextGen Financial Services Report again next week for the final five items on our “Top 10 List” of key issues that financial institutions, financial services providers, and fintech entities should watch in 2019.
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