JONES DAY TALKS®: All Talk, No Action? The Fintech Regulatory Plot Thickens
Jones Day’s new Of Counsel Nathan Brownback and Partner Josh Sterling discuss recent developments in the U.S. legal landscape for fintech, including the bipartisan Stabenow-Boozman bill, designed to regulate digital assets. They also talk about key banking and financial services developments, including the FDIC’s recent crypto advisory, California’s proposed, far-reaching Digital Financial Assets Law, and other issues in the space that will shape the fintech regulatory debate moving forward.
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A full transcript is below.
Dave Dalton:
Fintech law is evolving and changing quickly. So if you're looking for an overview of the latest developments, stay tuned. Jones Days, Josh Sterling and Nathan Brownback are here to talk about the Stabenow-Boozman bill that's Washington's bipartisan proposal to regulate digital currencies. They'll also talk about the FDIC's advisory to ensure institutions regarding deposit insurance and dealings with crypto companies. And the California state legislature is considering a far reaching digital assets law with a focus on consumer protections. What a show. I'm Dave Dalton, you're listening to JONES DAY TALKS®.
Josh Sterling has 20 years experience in the derivatives and securities markets, both as a lead council to major companies and as a senior federal financial regulator. Josh represents clients that are active in the derivatives markets with matters before a number of self-regulatory organizations. Prior to joining Jones Day, Joshua director of the US Commodity Futures Trading Commission, that's the CFTC market participants division. And regular listeners to JONES DAY TALKS® know that Josh is a frequent and popular contributor to this podcast. And Nathan Brownback's practice focuses on the regulation of domestic and foreign banks with particular emphasis on regulations under the Dodd-Frank Act, including the Volcker Rule. He also advises on bank holding company regulations, bank affiliate transactions, merchant banking rules, state commercial lending, and money transfer licensing issues, and other legal issues relating to Fintech and cryptocurrency firms. Nathan, Josh, thanks for being here today.
Nathan Brownback:
Thank you for having us, Dave.
Josh Sterling:
Thanks Dave.
Dave Dalton:
Really have been looking forward to this program. Nathan, welcome to Jones Day, you're a relatively recent arrival. Tell us a bit, if you don't mind, about your background, what you're doing prior to coming to the firm and anything else you'd like our audience to here and know.
Nathan Brownback:
Sure. And again, thanks for having me. I have been working for law firms in the banking space, both regulatory and transactional for the last eight years. My career as a banking lawyer started during the time when compliance with DODD-Frank was the key issue for everybody to deal with. I dove into that to start with. As time has gone on the big issues in banking and financial services have shifted from that period of responding to the financial crisis into a more normal expansionary phase of the economy and the rise of course, of Fintechs of various types, including both cryptocurrency and digital asset related Fintech and others. So I have at least done my best to move along with that shift in the business.
Dave Dalton:
That's true. Well, if I may say, you're joining a great practice group at a very interesting time. Where was law school?
Nathan Brownback:
Law school was Columbia. I finished in 2012, which is starting to feel like a long time ago.
Dave Dalton:
It is. Morningside Heights.
Nathan Brownback:
That's right, that's right.
Dave Dalton:
That's right. Love it. Thanks again for both being here today. Yeah, I really enjoy this type of program. Most of the time we focus in on one singular subject, there was a new regulation passed, there's new legislation, there was a court ruling somewhere. I like this kind of program, because we're doing a survey of recent events relative to a certain topic. And today's program is a banking and Fintech law update looking at some things that have happened in the last better part of the year. So let's start Nathan, with the Stabenow-Boozman bill. This is a bipartisan proposal to regulate digital currencies and it would charge the CFTC, which Josh knows all about, with considerable authority. Nathan, give us some background.
Nathan Brownback:
Sure. So one of the hot topics in the field, is how digital assets cryptocurrencies, and as this bill defines them, digital commodities are going to be regulated. There's nothing more in the forefront than that right now. The Lummis-Gillibrand bill that was released a few months ago and about which the firm has written and is writing, is one legislative proposal on that front, this is another. As you point out, it is bipartisan, the chair and the ranking minority member of the Senate Agriculture Committee with bipartisan support have issued this bill as another proposal. No way to be certain, of course, how the legislation will shake out once it starts to move forward and what version and which bill will come to the forefront, if any.
But for purposes of talking about this one, this Bill's designed to regulate "digital commodities." The bill has a framework where there's the defined term, digital commodity platforms, that includes a number of different types of firms and entities that have a relationship to the digital commodity space. So trading facilities and exchanges, brokers, dealers, custodians are all grouped together as digital commodity platforms. And if this legislation were enacted, all of those types of businesses would be required to register with the CFTC.
Dave Dalton:
CFTC, sure.
Nathan Brownback:
Yeah. So the bill would impose a number of requirements on registered digital commodity platforms relating to preventing abusive trading practices, disclosing conflicts of interest. It would make them subject to the BSA AML framework that currently exist for a number of kinds of financial institutions.
Dave Dalton:
Okay. Well, Josh, you and I have talked about regulations a lot in the fact that we need some guardrails at some point. Is this a good step forward from what you think, Josh?
Josh Sterling:
Yeah, thanks for that, Dave and thrilled to be here with Nathan. So I agree with that, I think if you look at this bill, there's a lot to be said about it, we will say things about it. The reception so far has been positive. One of the good things about the bill is the way it does define those platforms. It reflects the reality on the ground in two ways. One is, how those platforms operate. Those platforms offer a degree of intermediation, meaning acting effectively as a broker, in the way that traditional futures and derivative platforms themselves do not. So I think that's an important and meaningful distinction. The second way it reflects reality, is in the sense that we've seen over the past couple years, a number of large digital asset platforms acquire either futures brokers or derivatives markets themselves, technically called designated contract markets.
That's a clear signal with some pretty large check sizes that the industry would like to see a convergence of digital asset trading, this proverbial spot market with the trading of digital asset derivatives, the derivatives markets all under one banner, under one business, if you will. And therefore, all subject to regulation by one regulator, the CFTC. And so follows the secular trend of these acquisitions and a recognition that there are a number of digital assets that do look more like commodities than securities if you got to pick one. And they all ought to be regulated in the same way, give or take, or at least by the same regulator. So it makes a lot of sense in that regard.
Dave Dalton:
As Nathan mentioned, there's no guarantee what the final legislation, if it ever is passed, will look like. But either you have hunches, does this bill look like something everybody is pretty close to or could be pretty close to agreeing on?
Josh Sterling:
Yeah, it's been well received. It answers a lot of the important questions about who has primacy for this asset class and the manner in which rules should be written to regulate it better. And of course, they track more what the agriculture committee is familiar with, which would be the winner in which derivative markets are regulated. It's going to come down to a couple things. One, is who wins the jurisdictional battle between the agriculture committees, which oversee the CFTC and the banking and financial services committees, which oversee the SEC. And that comes down to appropriations and it comes down to who has influenced a particular industry, that might inform things like perhaps campaign contributions. Not something I'm going to get into here, but that's a common issue of who wants to have jurisdiction is driven by those considerations.
And there's a clear preference for many, from what I'm hearing, that the CFTC be the primary regulator. That can be imputed from how the CFTC is taken a more flexible, but still serious approach to accommodate many different kinds of asset classes, compared to the SEC where things are more axiomatically viewed as securities or not. And when they are viewed as securities, they're regulated in a very specific way, that frankly is still tied to legislation that at its core really hasn't changed that much from the 1930s. The markets, the investing public and the entities that are active in the markets have changed considerably. That's not to say the SEC's totally inflexible, heaven knows it's adopted plenty of rules over the years to adapt. But given the flexible nature and the adaptive nature of digitalized asset technology, the expectation for many is, that the CFTC would be better equipped. And so there's some hope that in this SEC versus CFTC's market regular debate, CFTC wins out.
And just one final point on that, there's also some legislation circulating for the regulation of stablecoins, something that's supposed to be pegged to a dollar or some other fixed value, so to speak. There's a strong preference out there, at least among legislators for the Fed to have that jurisdiction. You can look at a stablecoin and say, "Well, gee, it's like a prime money market fund." The SEC regulates money market funds. I think people would rather the Fed do that. So you have the CFTC with people having interest in having some jurisdiction as a market regulator, and you have the Fed where people have some interest in it, regulating a product is more of a prudential regulator. And you can say both those sentences without mentioning SEC, so there you go.
Dave Dalton:
That reflects a lot of what I've read, including some of the notes you've passed on, Josh. So it's going to be interesting to see how that situation unravels, that's for certain.
Josh Sterling:
I could be completely wrong and it wouldn't be the first time.
Dave Dalton:
I did have a note here relative to Stabenow-Boozman. Nathan, how would this specifically affect banks? I think you touched on it a little bit, but is it worth extrapolating a bit on that point?
Nathan Brownback:
Sure. Let me add one other thing before I do.
Dave Dalton:
Sure.
Nathan Brownback:
One of the goals of the bill appears to be establishing a degree of uniformity nationwide for digital commodity regulation. And one of the ways the bill does that is, that it would preempt all state law registration requirements that are currently applicable to the digital commodity platforms that the bill would regulate. So while that's not an effect on banks directly, it is an effect on the state banking regulators. Because there would be a lot of entities that they currently regulate, mostly as money transmitters under old laws not designed for digital assets, that would no longer be state regulated if this bill passed, but would move to the CFTC with a uniform, federal scheme of regulation. So that is a shift from state to federal regulation that this bill would certainly cause.
With respect to banks, there is a carve out in the bill from the definition of digital commodity custodian or any insured depository institution, any bank. So for a bank that is currently providing digital commodity services, they would not need to register separately with the CFTC under this framework. Though they would still be subject of course, to their own banking regulator's requirements, with respect to custody of digital assets. The OCC has issued guidance over the last few years on how national banks can comply with their expectations in that regard.
Dave Dalton:
I see. Every time we do one of these programs, I hear a new term, digital commodity custodian, that's a new one. I'm going to write that down.
Nathan Brownback:
Well, it's a new one, because it's a new one in this bill.
Dave Dalton:
Ah, good.
Nathan Brownback:
It's a defined term in the bill, so that's not something you were missing before, that actually is brand new.
Dave Dalton:
For once, I'm not hopelessly out of it, I'm just getting caught up.
Nathan Brownback:
Yep.
Dave Dalton:
That's great. Thanks. All right, Nathan, we're going to stay with you for a second and switch topics a little bit. Near the end of July, the FDIC issued an advisory to FDIC insured institutions regarding deposit insurance and dealings with crypto companies. What prompted this? What's in it? And what do we need to know?
Nathan Brownback:
All right. So let me give you a little background on this one first. The FDIC issued a final rule in the spring, regarding misrepresentations about deposit insurance. One of the reasons for that rule was the FDIC's view that in particular, issuers of stablecoins, but also others, in marketing materials and in disclosures were making statements that again, in the FDIC's view went too far towards suggesting that the stablecoin itself or potentially the reserve assets backing the stablecoin would carry FDIC pass through insurance. FDIC insurance covers deposit products, in some cases when the right boxes are checked and the right rules are followed, the insurance from the FDIC can pass through an account that's held for the benefit of another person through the third party, to the underlying depositor. So the FDIC rule was designed to make sure that if a company makes a claim about deposit insurance, that a given product has deposit insurance, that it has to be clear when deposit insurance passes through, when the FDIC would step in the case of a failed bank to provide those insurance payouts to depositors.
Dave Dalton:
Right.
Nathan Brownback:
And not make claims about deposit insurance when there's not a basis for those claims. So the advisory that came out, and citing back to the rule, said that banks who partner with Fintechs in any way, doesn't go into detail about what partnering with a Fintech necessarily means. But when a bank partners with a Fintech company that makes claims about deposit insurance, there is responsibility on the bank to monitor the disclosures, to monitor the marketing materials and do some of the FDIC's work under that final rule for it, make sure that deposit insurance claims are accurate and not misleading.
Dave Dalton:
All sounds reasonable. What brought this on? What prompted this, do you think?
Nathan Brownback:
There was some activity within the last, I would say, 18 months by state banking regulators looking into disclosures and marketing materials of stablecoin issuers and raising the issue to some of those issuers to say, "Look, you're making claims about deposit insurance that we think go too far." And the state regulators and the FDIC presumably were discussing those issues in the background. That was the first we became aware of the impetus toward the FDIC rule.
Dave Dalton:
Gotcha. Good summary, makes a lot of sense to me. We'll see how that unfolds certainly, certainly. Let's move to the other side of this great nation. We're leaving DC, we're heading to California. Everybody loves stuff out of California, right? The California legislature is considering a digital financial assets law, aiming to provide the cryptocurrency industry regulatory clarity and consumer protections by licensing and regulating the activities of cryptocurrency exchanges. I was reading that by the way, I'll come clean with the audience. Nathan, what's your initial reaction to this?
Nathan Brownback:
Right, okay. So first to explain where things stand, this is not legislation that is in effect yet. Again, like the federal legislation we're talking about at the top, we don't know whether this is going to be the final version of the bill in California. It's been approved by the assembly, still waiting action in the California State Senate. But if enacted, it would establish a new digital financial assets law in California, that would require any entity engaged in "digital financial asset business activity" to get a license from the state. It defines that business activity very broadly, exchanging, transmission, storage of a digital financial asset. Or, and very unclear how this definition is going to shake out, indirectly engaged in digital financial asset administration.
Dave Dalton:
Wow.
Nathan Brownback:
That could be a very broad sweep to bring in entities with a connection to California.
Dave Dalton:
Certainly.
Nathan Brownback:
It would impose on any digital financial asset business activity, any firm engaged in that disclosure requirements, record keeping requirements, they'd have to establish a customer service number and staff it. It would impose probably more importantly, a best interest standard comparable to the SEC's reg. BI requirements for broker dealers. It would require a number of policies and procedures in different areas, information security and data privacy is one of the important ones, BSA AML compliance is another.
Josh Sterling:
Sounds like the move to Florida digital platform regulation act if I may be so bold.
Nathan Brownback:
Yes.
Dave Dalton:
Yeah.
Nathan Brownback:
Probably not a lot of surprise that this is the sort of framework coming from California.
Dave Dalton:
Yeah, for sure. And they're always good or bad. It seems like that state's a little bit out in front, at least trying to negotiate what might make sense. And they put these things forward and given the size of the state and the size of its economy, I guess it makes some sense. Nathan, staying with you, but I'd like Josh's input here too. Michael Barr took office as a vice chair for supervision of the board of governors of the Fed Reserve system in mid-July, that's a four year term. What can you tell us about Mr. Barr? And what can we expect in terms of his view on crypto and Fintech in general?
Nathan Brownback:
So, Michael Barr was immediately before taking the role at the Fed was a professor at the University of Michigan. He's an economist. His writing is about financial regulation, provision of financial services, particularly to low income communities. He's a veteran of a number of White House and executive branch roles. He was part of the Obama administration when they were crafting the DODD-Frank act. To give you a sense of what his job is now, a lot of people outside the banking law community, think of the Fed as the body that raises or lowers interest rates and conducts monetary policy. But of course, the Fed also has a major role in regulating banks and bank holding companies and the financial service industry. And this is a specific role on the board of governors of the Fed for supervision of banking organizations. So he is in a role specific to the Fed's bank regulatory role.
It's hard to know exactly what his priorities are going to be, except that we know what he's written on, we know what his focus has been in the past, and we can infer what we can infer from that. One interesting note, in addition to the nomination that this was, the news also brings up two nominations that weren't. Very early in the Biden administration, the first rumored and reported name to be controller of the currency was Michael Barr. He was eventually not appointed. The administration's nominee, Saule Omarova, removed her name from consideration. And the current head of the OCC continues to be the acting controller. There's no prospect that I'm aware of, of any imminent nominee to head the OCC.
Dave Dalton:
Well, we're never overtly political on these programs, but isn't it getting a little late in a term to have that position still vacant?
Nathan Brownback:
Yeah, it is by historical standards, but not by the standards of recent years. The OCC has been headed by an acting comptroller for more of the last five or six years than it's been headed by a Senate confirmed head.
Josh Sterling:
Sometimes it happens.
Nathan Brownback:
That's been true in administrations of both parties.
Dave Dalton:
Interesting.
Josh Sterling:
Yeah, it's true, it is a little bit late in the game. Sometimes things like this happen. I know somewhat relatedly, I worked at the CFTC, it's still not reauthorized by Congress, so I can say that I worked in an illegal organization before coming to the firm. But it is unfortunate, Michael Barr, we are fortunate to have him in that position. I think he's highly respected and highly capable. I always think it's good for financial regulators to stay within the 40 yard lines of the proverbial football field and it seems like Mr. Barr would be there. I think we had a good success in supervision with his predecessor, Randy Quarles, and I would expect it to continue to go smoothly. I just think he's a highly respected individual and deservedly so.
Dave Dalton:
Real good, real good. One more question along this line, because I'm going to bring up another personality, I guess. Acting controller of Conservancy, Michael Hsu has talked about a new Fed rule regarding applying TLAC requirements, that's total loss, absorbing capacity requirements to large regional banks. Nathan, where are we in that process? And what might be the ramifications?
Nathan Brownback:
Now you saved the nerdiest question for last, I think.
Dave Dalton:
Sure. That's the genius of it, Nathan. That's the brilliance of it.
Nathan Brownback:
Let me give you a little background again. One of the main concerns of regulators in the DODD-Frank era, was trying to wrestle with the question of what happens when a bank that's too big to fail is failing. So several of the developments coming out of DODD-Frank was, how do we resolve large financial institutions? One of the requirements imposed by the Fed in its enhanced prudential regulation rules, was a TLAC requirement, total loss absorbing capacity, as you say. That requirement was imposed on the globally systemically important banks, the biggest and most complicated financial institutions in the United States. The idea is, that if you picture a bank's balance sheet, it has assets, it has liabilities, if the assets start to lose value, because of a shock, you're still solvent until they're even. And then as soon as the assets are a dollar under the liabilities, the bank is insolvent.
So what do you do in order to, well, prevent that from happening first? The regulators have requirements for TLAC, total loss absorbing capacity that can be met either through equity instruments issued by the bank or certain long term debt issued by the holding company. As the situation for a failing bank deteriorates, if it gets to the point of insolvency, but it has enough of that long term debt, the idea goes in a bankruptcy proceeding, long term debt holders of the old failed financial institution could be converted into equity holders. Instead of losing the debt entirely, they would become shareholders in the new bridge bank, the new financial institution that the FDIC would put together to salvage the bank. So the TLAC requirement generally is a way to try to prevent failure in the first place, to have a big enough cushion that failure doesn't happen.
The idea for the long term debt requirement is, if a failure does happen, if you go from a going concern to a gone concern, you can during the bankruptcy, convert that long term debt of the old institution to equity of the new institution and recapitalize it. So as I said, those requirements under DODD-Frank only applied to the most complex, the largest financial institutions, the G-SIBs. The speech the acting comp controller gave in April, and some reporting that has come out just in the last week, suggests that the current consideration at the Fed and the OCC, is to apply some of those concepts, not yet clear how or which exactly, other than that they're looking at the long term debt requirement to apply to large regional banks. A step down in size and complexity from the largest, most complex banks that those rules currently apply to.
Dave Dalton:
This is interesting, because as you said, we're stepping down to a different level of bank, I think maybe what we used to call super regional or whatever.
Nathan Brownback:
Yeah, exactly.
Dave Dalton:
Is this based on assets or number of branches or number of employees or reach? Or how do they define who would come under this regulation?
Nathan Brownback:
Well, again, there's no proposed regulation available yet, so we can't say concretely.
Dave Dalton:
Okay.
Nathan Brownback:
But given the current requirements on the G-SIBs, it would be based on asset size and complexity.
Dave Dalton:
Okay, okay. You know what? We've covered so much and a relatively short period of time. Nathan, I hope you come back and in fact we'll make sure of that, you were terrific. And how was your first experience with JONES DAY TALKS®? Did you enjoy it?
Nathan Brownback:
Absolutely.
Dave Dalton:
Yeah.
Nathan Brownback:
If you invite me back, I'll be back.
Dave Dalton:
That's good to hear. Let's wrap up with this, I want to talk just a little bit about the financial markets practice here at the firm. Maybe I'll flip to Josh real quick. Two things, Josh, tell me about where the focus is for our FinMar practice right now. And what does it mean to have people like Nathan coming in to this already very capable, robust practice? What do you feel about that?
Josh Sterling:
Well, thanks for that, Dave, happy to discuss that. I would say too, that we're lucky to grab Nathan for this podcast, because we were beating back Joe Rogan's staff to get him on here instead. So let me say this, I'm really excited that Nathan is here. I think that the financial markets practice is a demonstrated track record with our 311 lawyers across the firm, of working for banks of scale here, worldwide on their most challenging transactional issues, regulatory issues, government enforcement issues and litigation matters. And so having someone with a deep background in a long track on which to practice in core bank regulatory issues is vitally important. Clients demand and expect that, we're in an excellent position as we have been to continue to provide that well into the future.
And I think banking is an area that we will continue to strengthen given the demands for our clients in the space and let's face it, the increasing, well complexity, not only of the regulatory framework, which will only grow, but the complexity of financial services themselves. A lot of this, if it's not already will see and be digitally native. And so what we call traditional finance or TradFi and Fintech, will in some respects, probably converge and inform and adapt each other. And even our corporate clients are interested in payment services and other banking or bank-like services.
Dave Dalton:
Right.
Josh Sterling:
So to continue to be important to our clients and help them solve their most important challenges and pursue their most important opportunities, is vital to us. And we're very happy to have Nathan in the fold to help us execute on that.
Dave Dalton:
Well, I got to say, like I mentioned at the top of the program, you're in a very interesting practice area and things are evolving so quickly here, so I think you're both going to be very, very busy. So I sure appreciate your making some time for us today. Josh, Nathan, thanks so much for being here and we'll do this again soon.
Josh Sterling:
Thank you, sir.
Nathan Brownback:
Thanks for having us.
Dave Dalton:
Take care. You can find complete biographies for Josh Sterling and Nathan Brownback at jonesday.com. Be sure to visit the site's insights page, you'll find more podcasts, publications, videos, blogs, newsletters, and other timely information. Subscribe to JONES DAY TALKS® at Apple Podcasts, Spotify and wherever else you find your podcasts. JONES DAY TALKS® is produced by Tom Kondilas. As always, we appreciate your listening. I'm Dave Dalton, we'll talk to you next time.
Speaker 4:
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