Financial Services Alert - April 2, 2013

Goodwin Procter’s Private Investment Funds Practice issued a Goodwin Procter Alert that provides an update for non-European private fund managers on rules under the European Union Alternative Investment Fund Managers (AIFM) Directive that, effective July 22, 2013, will govern the marketing and operation of alternative investment funds within the European Economic Area (EEA).

On April 17, 2013, Goodwin Procter will be hosting a breakfast seminar on the AIFM Directive in its Silicon Valley office.  If you are interested in attending this event, please contact us here for more information.

Goodwin Procter’s ERISA Litigation Practice published its latest quarterly ERISA Litigation Update.  The update discusses:

• a Ninth Circuit decision affirming the district court’s rulings in the Tibble case previously reported in the ERISA Litigation Update.   Tibble v. Edison International, Nos. 10-56406, 10-56415, 2013 WL 1174167, No. 11-56628, 2013 WL 1150788 (9th Cir. Mar. 21, 2013).
• a Fourth Circuit decision affirming dismissal of claims and summary judgment in a suit challenging a financial services company’s use of proprietary products in its retirement plans.   David v. Alphin, 704 F.3d 327 (4th Cir. 2013).
• a Second Circuit decision affirming in part, and vacating and remanding in part, a decision by the United States District Court for the Southern District of New York dismissing all claims as to the inclusion in two 401(k)-style plans that allowed participants to invest in the stock of the sponsoring employer.  Taveras v. UBS AG, 708 F.3d 436, No. 12-1662, 2013 WL 692720 (2d Cir. Feb. 27, 2013).

The International Swaps and Derivatives Association (“ISDA”) released the ISDA March 2013 Dodd-Frank Protocol, also known as “DF Protocol 2.0,” which became open for adherence on March 22, 2013.  Like its predecessor, the ISDA August 2012 Dodd-Frank Protocol (the “August Protocol”), DF Protocol 2.0 is intended to facilitate compliance with certain CFTC Dodd-Frank rulemaking by providing an efficient and standardized way of amending swap documentation to make changes responsive to the new rules. 

DF Protocol 2.0 is intended to address the requirements of three rules finalized in the latter half of 2012, too late to be covered by the August Protocol.  More specifically, DF Protocol 2.0 addresses the end-user exception to the clearing requirement for swaps (discussed in the July 17, 2012 Financial Services Alert), the clearing requirement determination that mandates clearing for certain classes of interest rate swaps and credit default swaps (discussed in the December 4, 2012 Financial Services Alert), and the rule entitled “Confirmation, Portfolio Reconciliation, Portfolio Compression, and Swap Trading Relationship Documentation Requirements for Swap Dealers and Major Swap Participants” (discussed in the September 4, 2012 Financial Services Alert).

The structure of DF Protocol 2.0 is similar to that of the August Protocol.  The Protocol Agreement defines the overall structure of DF Protocol 2.0 and includes common terms, representations, and agreements.   The DF Protocol 2.0 Supplement includes several schedules containing additional representations and agreements that adhering parties may elect to make.  Adhering parties must also complete and deliver to each of their counterparties a Protocol Questionnaire, which, among other things, provides certain identifying and contact information, identifies whether the adhering party falls into certain regulatory categories established in the Commodity Exchange Act and in CFTC regulations, and specifies whether the adhering party wishes to avail itself of certain exceptions or exemptions from the applicable CFTC rules.  As with the August Protocol, ISDA Amend, an online portal, may be used to automate the exchange of information and documents between counterparties.  Institutions that wish to adhere to DF Protocol 2.0 must submit an Adherence Letter to ISDA along with a one-time fee of $500. 

DF Protocol 2.0 is independent of the August Protocol.  Adherence to the August Protocol does not imply or require adherence to DF Protocol 2.0 (and vice versa).  Market participants that have chosen to adhere to one protocol should consider whether they wish to adhere to the other protocol as well, to the extent it is applicable.

The FRB, FDIC and OCC (the “Agencies”) jointly issued final updated guidance (the “Interagency Guidance”) concerning leveraged lending.  The Interagency Guidance updates guidance issued in April 2001.  The Agencies issued a proposed version of the Interagency Guidance on March 30, 2012 and requested public comment on the proposal, and the Interagency Guidance makes certain modifications to the initial proposal that reflect certain of the comments received by the Agencies.  The proposed version of the Interagency Guidance was discussed in the April 3, 2012 Financial Services Alert.  The Interagency Guidance describes the Agencies’ expectations regarding a financial institution’s sound risk management of leveraged lending activities.

The Agencies generally regard leveraged lending as a lending transaction characterized by a borrower with a degree of financial or cash flow leverage that significantly exceeds industry norms or historical standards as measured by various debt, cash flow or other ratios.  The Agencies state, however, that a financial institution engaged in leveraged lending should incorporate into its credit policies a definition that is appropriate to the financial institution and its business.  Moreover, the Interagency Guidance notes certain benchmarks that each financial institution’s definition should cover, e.g., a loan facility to a borrower with a total debt/EBITDA ratio of more than 4:1 or senior debt EBITDA of more than 3:1 is likely to be viewed by the Agencies as a leveraged loan.  The Agencies state that the Interagency Guidance provides high-level principles related to safe and sound leveraged lending that the Agencies expect a financial institution to consider before making a leveraged loan and during the administration of such a loan. 

The Interagency Guidance advises lenders to focus on, among other things:

1. identification of the financial institution’s risk appetite for leveraged lending (how much of such risk will be underwritten, and how much risk will be retained?);
2. risk management frameworks (e.g., credit limits, volume limits on leveraged finance transactions);
3. underwriting standards (e.g., cash flow capacity, covenant protection, collateral control);
4. valuation standards (determination of, and updates to, calculations and documentation of a borrower’s enterprise value);
5. timely measurement of transactions “in the pipeline” (e.g., need for periodic stress tests).
6. independent evaluation by purchaser of participations in leveraged loans of the risks assumed and the transaction as a whole;
7. risk management and controls over transactions in the pipeline (taking into account potential market disruptions and failed transactions);
8. reporting and analysis (e.g., information systems that accurately capture key obligor characteristics and aggregate them across business lines and legal entities); and
9. stress testing of leveraged loans held in portfolio as well as those planned for distribution.

The Agencies point out that there are few community banks with substantial involvement in leveraged lending and, accordingly, the Interagency Guidance should not have a substantial effect on community banks.  The Agencies also state that the Interagency Guidance does not apply to traditional asset-based loans.  The Interagency Guidance became effective on March 22, 2013, but the compliance deadline for the Interagency Guidance is May 21, 2013.

The FRB, FDIC, OCC, National Credit Union Administration and Farm Credit Administration (the “Agencies”) jointly issued an interagency statement (the “Interagency Statement”) on the impact of the revisions to the Flood Disaster Protections Act of 1973 (the “FDPA”) made by the Biggert-Waters Flood Insurance Reform Act of 2012 (the “Act”).

The Interagency Statement notes that changes to certain force placement provisions of the FDPA and an increase of the maximum civil money penalty to $2,000 for each violation of the FDPA became effective on July 6, 2012, the date of enactment of the Act.  The amendments to the force placement provisions of the FDPA provide that:

• premiums and fees for which a borrower may be charged include premiums or fees incurred for coverage beginning on the date on which flood insurance coverage lapsed or on which the borrower did not provide a sufficient amount of money to obtain coverage;
• a lender or servicer, within 30 days of receiving a confirmation of a borrower’s existing flood insurance coverage, must terminate any force-placed insurance and make a refund in an appropriate amount to the borrower;
• a lender or servicer must accept, as confirmation of the borrower’s existing insurance coverage, a declaration page with the borrower’s existing flood insurance policy number and certain information about the insurance company or insurance agency.

The Interagency Statement also notes that the following three requirements of the Act are not yet effective and will not be effective until implementing regulations are issued by the Agencies.  Those provisions require that: (1) lenders accept private flood insurance policies if the coverage satisfies standards set in the Act; (2) lenders disclose to borrowers certain information regarding the National Flood Insurance Program; and (3) certain lenders and servicers establish escrow accounts for flood insurance premiums and fees for certain loans.