January 5, 2021 - The LSTA this week filed a comment letter in connection with an important notice of proposed rulemaking (“NPR”) issued by a number of federal banking agencies in mid-October.  As we discussed at the time, the proposed rule would formally establish that regulatory guidance is non-binding and cannot form the basis for a Matter Requiring Attention letter (“MRA”).  The proposed rulemaking mirrors, and would codify as a formal rule, an interagency statement (the “2018 Statement”) issued by the federal agencies in September 2018. 

Why is the proposed ruling so important to the loan market?  In 2018 the banking agencies, in response to questions from Senator Pat Toomey regarding the 2013 Leveraged Lending Guidance, issued the 2018 Statement affirming that “supervisory guidance does not have the force and effect of law” and that the agencies “do not take enforcement actions based on supervisory guidance.” Even more specifically, the agencies said that they will limit the use of numerical thresholds, or “bright-lines”, and will only use them as examples (not requirements).  They also stated that they will not “criticize” an institution for a “violation” of supervisory guidance.

In the NPR, the agencies recognized the distinction between issuances that serve to implement acts of Congress (“rules” or “regulations”) and non-binding “supervisory guidance documents”.   Regulations create binding legal obligations while supervisory guidance is issued “to advise the public prospectively of the manner in which the agency proposes to exercise a discretionary power” and does not create binding legal obligations.

The NPR codifies the 2018 Statement and adds some clarifying changes, the most important of which is to make clear that the term “criticize” includes the issuance of MRAs and similar supervisory criticisms.  As such, the agencies reiterate that examiners will not base such supervisory criticism on a “violation” or non-compliance with supervisory guidance.   Finally, in response to a request that supervisory criticisms should not be “generic” or “conclusory” references to safety and soundness, the agencies agree that supervisory criticisms will be “specific as to practices, operations, financial conditions, or other matters that could have a negative effect on the safety and soundness of the financial institution, could cause consumer harm, or could cause violations of laws, regulations, final agency orders, or other legally enforceable conditions.”

In its comment letter the LSTA strongly supports the Agencies’ reaffirmation of the non-binding nature of supervisory guidance and the codification of the Agencies’ policies concerning the use of supervisory guidance.  By clarifying that a “violation” of or “non-compliance” with supervisory guidance cannot be used as the basis for supervisory criticism or enforcement action, the Agencies remove ambiguity that could deter supervised financial institutions from innovations and developments that may not fit squarely within existing guidance and could discourage them from engaging with examiners. In particular, the LSTA applauds the Agencies for specifying that supervisory criticism includes the issuance of MRAs and similar memoranda, and that supervisory criticism should be “specific as to practices, operations, financial conditions, or other matters that could have a negative effect on the safety and soundness of the financial institution, could cause consumer harm, or could cause violations of laws, regulations, final agency orders, or other legally enforceable conditions.”

The LSTA also strongly urged the Agencies to provide more clarity as to the universe of guidance documents that fall within the scope of the NPR.  In particular, the LSTA expressed concern that the NPR’s reference to certain types of materials, such as interpretive rules, that the Agencies believe are not supervisory guidance creates significant confusion. Even if interpretive rules were the only exception contemplated by the Agencies, the distinction between interpretive rules and supervisory guidance is vague because supervisory guidance that articulates “appropriate practices for a given subject area” will necessarily reflect an agency’s interpretation or construction of the regulations that apply to that subject area. Without a clear and practical way of determining the universe of supervisory guidance, the LSTA expressed concern that the NPR will be limited by endless disagreements as to its scope.  Finally, in response to the Agencies’ request for comment on whether examiners should reference supervisory guidance when criticizing a supervised financial institution, the LSTA urged the Agencies to carefully circumscribe the extent to which examiners may be permitted to reference supervisory guidance in writing.  Permitting examiners to reference supervisory guidance in supervisory criticism will inevitably create the impression that non-compliance with such supervisory guidance has led to the supervisory criticism.

What’s Next?  In the normal course, the agencies would review the comments and issue a final rule.  Given the change in the presidential administration and the potential appointment of new heads of some of the Agencies, it is too early to say whether this proposed rulemaking will follow that path.  The LSTA will continue to follow this matter closely.

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