On July 27, 2023, the US banking regulators issued a proposal to significantly revise the risk-based capital requirements applicable to large banks and to banks with significant trading activity. The proposal, which is colloquially referred to as “Basel III Endgame” or “Basel IV,” includes important changes to the calculation of credit risk weights for securitization exposures, as well as a new operational risk capital charge on certain fees and commissions. Mayer Brown’s white paper provides a detailed review of those changes, discusses their possible impacts, and highlights specific provisions that market participants will likely focus on in their comment letters. Please read more here.
The regulatory and judicial developments of the last few days relating to the loan markets and to loan funds have been significant.
On Tuesday, lenders and borrowers were concerned about a world in which syndicated and other loans would be treated as securities. And managers of collateralized loan obligation vehicles (“CLOs”) were concerned about being subject to extensive new Federal regulations. Both of these concerns were addressed this week.
On Wednesday afternoon, the SEC announced a final Private Fund Adviser Rule that has a broad exception for “securitized asset funds,” a category that includes CLOs. The SEC’s Release with the final Rule is here. An Update that we issued regarding the final Rule is here.
Then, on Thursday morning, the Second Circuit issued a decision in the closely watched Kirschner v. JPMorgan case rejecting the plaintiff’s argument that the subject notes associated with syndicated term loans should be treated as securities.
What does all of this mean for the loan markets?
- Managers of, and investors in, CLOs are relieved after potentially facing demanding new Federal regulations.
- Sponsors of, and investors in, other loan funds also will benefit from the SEC’s significant paring back of its Private Fund Adviser Rule. Beyond the possibility of satisfying the securitized asset fund definition, many of these market participants will also be able to avail themselves of rule exceptions that should, among other things, limit new obstacles to certain agreed side-letter arrangements tailored for certain investors.
- The loan markets, and the loan fund universe, won’t have to deal with the substantial complications for origination and trading that would have accompanied a Second Circuit decision that certain syndicated loans are securities. These complications could have also impacted other markets that utilize loan-based funding, such as asset based lending and non-ABS structured finance markets.
No doubt there will be future twists and turns in regulation and in the courts that will pose challenges for the loan markets. But the developments of Wednesday and Thursday might be remembered for a while as the August 2023 Doubleheader.
Following closely on the heels of a Georgia law enacted in May, Connecticut and Florida have become the latest states to enact laws requiring providers of small business financing to provide disclosures to recipients—and in Connecticut’s case, to require certain commercial finance providers to register with the state. We examine the unique and interesting provisions in these laws, and what the new laws might signal for the regulatory landscape in coming years, in Mayer Brown’s Legal Update.
On 20 July 2023 the long awaited Electronic Trade Documents Act 2023 (the Act) received Royal Assent, and will come into effect in the UK on 20 September 2023.
The Act, which is largely based on the UK Law Commission’s draft Bill published in March 2022, sets out the basis upon which trade documents can exist and be dealt with in electronic form under English law, such that an electronic trade document has the same effect as an equivalent paper trade document.
Read more in Mayer Brown’s Legal Update.
Earlier this year, the SEC re-proposed a rule to implement Section 27B of the Securities Act of 1933, a provision added by Section 621 of the Dodd-Frank Act.
The Dodd-Frank provision, intended to prohibit certain conflicts of interest in securitization transactions, is interpreted broadly by the SEC’s sweeping proposal. If not amended, these rules would threaten the viability of many common, beneficial transactions in mortgage- and asset-backed securities.
On Tuesday, June 20 from 1:00 – 2:00 p.m. EST, please join SIFMA’s Chris Killian and Mayer Brown’s Christopher Horn, Stuart Litwin and Michelle Stasny in this webinar as they discuss the proposed rule, the rule’s potential impact, the industry’s response and the issue’s trajectory.
Registration for the webinar is located here: Register for the SIFMA Webinar: SEC Re-Proposal on Conflicts of Interest in Securitization (hs-sites.com).
Christopher Horn, Counsel, Mayer Brown LLP
Stuart Litwin, Partner, Mayer Brown LLP
Michelle Stasny, Counsel, Mayer Brown LLP
Chris Killian, Managing Director, Securitization and Corporate Credit, SIFMA
Providers of commercial financing should take note that Georgia has become the fifth US state to enact small business financing disclosure requirements since California started the trend in 2018. Georgia Senate Bill 90 was signed by Governor Brian Kemp on May 1, 2023, and takes effect January 1, 2024. The Georgia law applies to transactions of $500,000 or less, including closed and open-end loans and accounts receivable purchases, and provides some helpful exemptions for equipment financers, affiliates of depository institutions, and others. Mayer Brown’s Legal Update provides details on the law’s requirements, scope, exemptions, and penalties.
Banking organizations looking to reduce the amount of risk-based regulatory capital required to support residential mortgage loan portfolios can use synthetic securitization to convert the capital treatment of their exposures from wholesale or retail exposures to securitization exposures. In this Legal Update, we discuss how regulatory capital requirements impact banking organizations that hold portfolios of residential mortgage loans and how synthetic securitization can help mitigate the capital charge associated with these portfolios.
Read more in Mayer Brown’s Legal Update.
Welcome to the second edition of Licensing Link, a periodic publication that will keep you informed on hot topics and new developments in state licensing laws, and provide practice tips and primers on important issues related to state licensing across the spectrum of asset classes and financial services activities. We look forward to you joining us for future editions!Continue Reading Licensing Link
In its current form, the Uniform Commercial Code (“UCC”) does little to accommodate emerging technologies such as cryptocurrencies and non-fungible tokens. In efforts to modernize and adapt the Uniform Commercial Code to newer technologies, the Uniform Law Commission (the “ULC”) and the American Law Institute have jointly sponsored the drafting of proposed extensive amendments to the Uniform Commercial Code, particularly in respect of new Article 12 (the “UCC Amendments”). In July 2022 the ULC adopted the UCC Amendments as a model law which is now recommended for enactment by state legislatures throughout the U.S. in its entirety or with non-uniform state-specific variations. We note that presently preliminary versions of Article 12 have been adopted in Nebraska, New Hampshire and Iowa, and Wyoming has recently enacted the Stable Token Act. North Dakota has adopted the UCC Amendments in their entirety.
UCC Articles 3 and 9 govern the sale and pledge of negotiable instruments (i.e., drafts and bills of exchange). The significance of the proposed UCC Amendments in respect of drafts and bills of exchange is that they eliminate the current UCC Article 3 requirement that such drafts/bills of exchange be in a traditional paper form and “signed” with wet ink signatures. The is a significant and very positive change because under revised Article 3 and new Article 12, there may be no further need to produce and deliver a physical negotiable instrument. Elimination of the requirement of a paper draft will solve long-standing problems that have significantly constrained the growth of draft/bill of exchange-based financing structures in trade finance transactions. The current UCC requirements for paper transfer of drafts/bills of exchange signed by the seller, circulated to the buyer for signature/acceptance and then endorsed and vaulted for safe-keeping or delivered to the seller’s bank leads to cumbersome processes, delays and expense, limitations that negatively impact the financing, and purchase and sale of goods and services in the U.S. and beyond. Replacement of physical drafts with electronic drafts has the potential to eliminate these problems and spur the rapid growth of digital drafts/bills of exchange transactions and high volume buyer-led digital drafts financing programs across the globe. The existing Uniform Electronic Transactions Act (“UETA”) which has been implemented 49 states (excluding New York State) and the Federal ESIGN Act (“ESIGN”) and similar “electronic records-related” legislation in other countries have paved the way for the innovations reflected in revised Article 3 and new Article 12 by increasing efficiencies and stimulating the growth of commercial transactions generally.
Revised Article 3 facilitates the transformation of a physical negotiable instrument to an electronic record in tandem with new general definitions in UCC Section 1-201. Among other changes, new Subsection 3-105(a)(2) permits an instrument to be issued by an electronic transmission of an image and information derived from the instrument by the maker and drawer, rather than by physical delivery. As a general matter, terms that applied only to paper transactions in the UCC have been omitted entirely from the UCC Amendments or redefined to encompass electronic transactions. For example, definitions set forth in Section 1-201 have been amended so that the defined term “sign” now encompasses electronic signatures, “record” has replaced “writing,” and “conspicuous” has been redefined to broadly encompass both paper and electronic agreements. The first two amended terms are directly relevant to digital drafts/bills of exchange to the extent they gain traction in the marketplace as viable commercial assets.
The New Article 12 in the UCC Amendments creates a class of digital assets defined as “controllable electronic records” (“CERs”). A CER is a “record stored in an electronic medium that is susceptible to ‘control.’” The UCC Amendments provide for a CER to be, in effect, negotiable, i.e., capable of being transferred in such a way as to cut off competing property claims (including security interests) to the CER. The UCC Amendments also provide for a security interest in a CER to be perfected by “control” to have priority over a security interest in the CER perfected only by the filing of a financing statement. The control test in Article 12 is intended to work with systems that satisfy the requirement of control under UETA, as well as new technologies. At a high level, Article 12 would extend the concept of “control” currently used with respect to certain other types of electronic records such as a “transferable record” under ESIGN and the UETA to the concept of “controllable electronic records” under the UCC Amendments.
“Accounts” or “payment intangibles” (as those terms are defined in UCC Article 9) can be evidenced by a CER, creating a “controllable account” or “controllable payment intangible” if the party obligated on the account or payment intangible has agreed to pay the person in control of the CER. If control of a CER that evidences a controllable account or controllable payment intangible is transferred, the controllable account or controllable payment intangible travels with the CER, and the transferee, if a “qualifying purchaser,” benefits from the same “take-free” rule that applies to the CER. A “qualifying purchaser” is a purchaser that obtains control of a CER for value, in good faith, and without notice of a claim of a property right in the CER, analogous to the current UCC Article 3-302 definition of a “holder in due course” in respect of a purchaser of negotiable instruments. The effect is to create what is functionally an electronic instrument even though the payment rights continue to be classified as a “controllable account” or “controllable payment intangible.”
If the terms of the account or payment intangible also provide that the account debtor will not assert claims or defenses against the transferee of the CER (as, and to the extent, permitted by UCC Section 9-403), the effect is to create the substantial electronic equivalent of a negotiable instrument. However it is important to note that a negotiable instrument under Article 3 and a payment intangible under Article 12 that works in a functionally equivalent way, are not one and the same: in order for an electronic form of a physical draft to meet the Article 12 requirements, the content of the traditional draft would need to be altered to replace “pay to the order of” with a buyer’s “promise to pay to the person in control of such draft” and additionally, such draft would need to state on its face that the buyer agrees not to assert claims or defenses against any transferee.
These Article 12 CER “control” provisions are intended to address market concerns in the trade finance area that commercial law rules are currently insufficient to support widespread electronic drafts/bills of exchange programs. In short, Article 12 gives a drafts/bills of exchange purchaser who is in control of the related CER the same type of holder-in-due-course priority achieved by such purchaser under the current version of Article 3 in respect to the possession of a physical draft/bill of exchange, that is, the right to take an interest in the record (e.g., a draft or bill of exchange) free of most competing claims, even if that competing claim has otherwise been perfected under the UCC. The UCC Amendments could, in theory, have a profound impact on trade finance. Nonetheless there are a number of obstacles to practical implementation. While some banks or Fintechs may be able to gear up to meet the Article 12 control tests for CERs right away, such parties face significant practical hurdles to widespread adoption. These technologies may go mainstream or they may not, and even if they do become the norm, the timing of when they might happen is uncertain, particularly in the wake of the recent string of scandals and bankruptcies involving crypto currencies. Given these challenges, there is a great deal of uncertainty whether the transfer or pledge of digital assets will become routine. Whether new Article 12 has any real practical application, at least in the short term, remains to be seen. Moreover, new Article 12 will have limited utility as far as cross-border trade finance transactions are concerned. If one of the parties to the transaction is outside of the U.S., it is a given that the entity is residing either in a jurisdiction that does not recognize the concept of digital assets or has a differing interpretation as to how those assets can be sold or pledged. For example, the UNCITRAL Model Law on Electronic Transferable Records (2017) (“MLETR”) addresses many of the same issues as Articles 12 and 3 of the UCC Amendments but approaches those issues entirely differently. If the jurisdiction of the non-U.S. counterparty has adopted MLETR, then there will likely be an inconsistency or conflicts of law in how the finance or sale of digital assets is addressed. Also, it is not clear how quickly MLETR – or other similar laws in respect of digital assets or electronic records – will be prevalent across the globe. If the jurisdiction does not recognize the concept of digital assets, then any proposed cross-border transaction involving that jurisdiction and digital assets may have significant enforceability issues.
 MLETR has to date been adopted in Singapore, Bahrain and Abu Dhabi.
The US Consumer Financial Protection Bureau (CFPB) has finalized its December 2022 preliminary determination that commercial finance disclosure laws recently enacted in California, New York, Utah and Virginia are not preempted by the federal Truth in Lending Act. The CFPB’s final determination confirms for a wide range of small business financers and brokers that they are presumptively required to comply with existing (and future) state disclosure and registration obligations, absent an exemption. Read more about the CFPB’s reasoning and some key takeaways in Mayer Brown’s Legal Update.