Part II: Amendments Not Primarily Affecting Sweep Programs
On December 15, 2020, the Board of Directors of the Federal Deposit Insurance Corporation (“FDIC”) adopted amendments to the FDIC’s brokered deposit regulations (the “Amendments”).1 The Amendments are significant and broadly written. They make important changes to both the definition of “deposit broker” and the available exceptions to that definition. The Amendments become effective on April 1, 2021.
This is the second of two Client Alerts we have prepared about the Amendments. The first Client Alert, dated December 23, 2020, addressed how the Amendments affect so-called “sweep programs” offered by broker-dealers and other financial institutions. This Client Alert will address more generally how the Amendments affect the determination of whether a deposit arrangement should be characterized as a brokered deposit.
The Amendments should result in fewer deposit arrangements being considered brokered deposits. However, the Amendments do not change the regulatory treatment accorded to deposits that are considered brokered. Brokered deposits are still subject to higher deposit insurance premiums in certain cases, are still treated as “non-core” deposits for purposes of FDIC call reports, and are still subject to higher deposit run-off rates for purposes of determining a bank’s liquidity coverage ratio.
We also observe that the Amendments are not grounded in clearly described or consistent policy goals, which will undoubtedly pose challenges in applying the Amendments to novel deposit arrangements. The ground on which the FDIC’s brokered deposit regulations rested was uneven before the Amendments, and it remains uneven.
B. Overview of Amendments Not Chiefly Affecting Sweep Programs
In addition to the changes discussed in our first Client Alert (Part I), the Amendments make the following key changes, discussed in more detail below:
- A new exclusion from the definition of “engaged in the business” of placing, or facilitating the placement of, deposits for purposes of the deposit broker definition. This exclusion, for “Exclusive Deposit Placement Arrangements,” is intended to capture arrangements where a third party that would have previously met the deposit broker definition, because it was placing, or facilitating the placement of, deposits with at least one bank, has such an arrangement with one bank only will no longer meet the deposit broker definition. The FDIC expects that the third party relying on this exclusion will often be a financial technology, or “FinTech,” company or a wholly-owned subsidiary of the bank.
- A new category of the “primary purpose exception” (“PPE”) for funds placed at banks “for the purpose of enabling transactions,” which effectively creates an exception from the deposit broker definition for payment processors and money transmitters.
- A list of business arrangements that are deemed to satisfy the PPE without notice or application, in each case, based on previous FDIC staff opinions regarding an existing arrangement (“Additional Designated Exceptions”). Staff opinions approving arrangements under the PPE other than those formalized as Additional Designated Exceptions will continue to be recognized until January 1, 2022.
- An application process for other business arrangements that an applicant believes meet the PPE. Approved applications may be posted in redacted form on the FDIC’s website and other applicants may cite such approvals in their own applications. The FDIC may also choose to designate certain such future arrangements that it approves as new Additional Designated Exceptions.
As we discuss further below, we observe that – surprisingly – in most circumstances the FDIC will no longer take fees received by a putative deposit broker into account in determining whether a given arrangement meets the PPE. We also observe that the Amendments leave unchanged the current status of brokered CDs, which remain brokered deposits in all circumstances.
C. The FDIC’s Brokered Deposit Policy Rationale
I. Modernization in Response to Technology
The statute defining the term “deposit broker” and imposing limitations on the acceptance of brokered deposits was adopted as part of legislation addressing the savings and loan crisis of the 1980s.2 The definition, including the exceptions, was adopted in 1989 and the limitations on brokered deposits were adopted in 1991 without modifying the definition.3 No significant changes have been made to the statute since then.
In a section of the preamble to the Amendments titled “Policy Objectives,” the FDIC acknowledges that its regulations are “outdated” and “do not reflect current industry practices and the marketplace.”4 The FDIC notes that “the marketplace for brokered deposits has evolved in response to technological developments and new business relationships” and that banks work with third parties, “including financial technology companies,” for access to deposits.5 “Moreover, banks are increasingly relying on new technologies to engage and interact with their customers….”6
Unfortunately, the FDIC did not provide examples of the types of technological innovation or specific changes to the marketplace for bank deposits that inform the Amendments. More importantly, the FDIC does not articulate what policies it believes the brokered deposit regulations should effectuate and how the Amendments implement those policies. For example, the Amendments contain no discussion of why high rate deposits attracted by a bank using the internet retain the characterization of “core” deposits, while lower cost deposits that are brokered are not “core.” As we have long advocated, the distinction between “core” and “brokered” is meaningless in today’s market.
II. Deposit Stability
As discussed in more detail below, the Amendments create a new exclusion from the deposit broker definition for Exclusive Deposit Placement Arrangements between third parties and banks. In doing so, the FDIC asserted that such an arrangement is less likely to make the deposits “less stable.”7 Notwithstanding the fact that this could be a beneficial precedent for the industry, the FDIC adduced no evidence of the stability of such Exclusive Deposit Placement Arrangements in creating this new exception.
The FIDC’s “stability” rationale is particularly striking because deposit stability is not a statutory ground on which the FDIC is expressly permitted to rely in its brokered deposit rules. Rather, the statute looks merely to whether a person places deposits with a bank, and not to the characteristics of the deposits placed. The FDIC has never before created an exclusion or other exemption based on the stability of the deposits or suggested that deposit stability could form the basis for acknowledging future exemptions.
If the FDIC believes it has the authority to use deposit characteristics as a basis for determining brokered vs. non-brokered status, authority it has never claimed before, will it be willing to grant exclusions or exemptions to other deposit arrangements that are demonstrably stable? For example, long-term brokered CDs? As discussed further below, the Amendments provide that all brokered CDs, without drawing distinctions based on maturity and “without exception,” will continue to be classified as brokered deposits.8
The discussion in the Amendments regarding this exclusion evidences the FDIC’s inconsistent rationale in applying its statutory authority to brokered deposit arrangements. Without clear guiding principles and defined aims, the Amendments do not reflect a consistent and coherent policy on brokered deposits. Absent such principles and aims, the brokered deposit regulatory terrain may continue to be uneven going forward.
III. Reduced Focus on Fees
Historically, the FDIC has focused on whether a third party receives fees from a bank, particularly volume-based fees, in determining whether the third party is a deposit broker. But, as described in more detail in Part I of this Client Alert, the receipt of fees by a third party is no longer a primary consideration in determining whether the third party is “facilitating the placement of deposits,” though the FDIC does reserve some discretion in evaluating fees received by third parties when considering applications for the PPE, and still considers them in the context of the Payments Exception, as defined and discussed below.
In fact, the Amendments go so far as to state that “[u]nder the definition of facilitation, it is unlikely that a third party that is, for example, providing general marketing or advertising services on behalf of a bank (e.g., providing a link on its website) in exchange for a volume-based fee, will meet the deposit broker definition.”9 Given the FDIC’s prior focus on fees, this statement is an extraordinary course reversal.
Under the Amendments, in certain relationships meeting the PPE, a bank can pay a given third party any amount of fees based on volume, without losing the exception. This also means that the third party qualifying for an exception can move deposits at will to collect higher fees from willing banks. How does this effectuate a policy of encouraging deposit stability?
D. New Definition of Facilitation
The definition of “deposit broker” in Section 29 of the Federal Deposit Insurance Act includes third parties that “facilitate” the placement of deposits. The Amendments provide an expanded definition of “facilitation” which includes third parties engaged in “matchmaking activities,” a new category of facilitation. Part I of this Client Alert contains a more fulsome description of the new definition.
E. Exclusions and Exceptions Created by the Amendments
I. Exclusion for Exclusive Deposit Placement Arrangements
The Amendments create a new exclusion from the deposit broker definition for situations in which a third party forms an arrangement with a single bank to establish exclusive deposit placement services.10 A bank can have such Exclusive Deposit Placement Arrangements with more than one third party with the deposits placed by each third party qualifying for the exclusion.
The Amendments discuss two scenarios in which the FDIC expects the new exclusion to be relevant. The FDIC expects the exclusion for Exclusive Deposit Placement Arrangements would be applicable to circumstances where a FinTech company partners with one bank, and also to circumstances where the bank’s wholly-owned subsidiary acted as a deposit broker placing (or facilitating placement of) deposits with its parent bank.
II. The Payments Exception
The Amendments provide that deposits placed for the purpose of “enabling transactions” will per se fall within the PPE if a third party places 100 percent of its customer funds within a given line of business into transaction accounts and “no fees, interest, or other remuneration is provided to the depositor.”11
Nonetheless, the FDIC may permit some fees or interest to be paid to depositors without the deposits being considered brokered in some circumstances. In these cases, a bank may still apply to the FDIC for the PPE, which the FDIC states that it will grant if the depositor earns “a nominal amount” of fees or interest or the depositor makes, on average, more than six transactions per month.12
The FDIC specifies in the Amendments that this exception is intended to “apply only to third parties whose business purpose is to place funds at depository institutions to enable transactions or make payments.”13
III. Additional Designated Exceptions
The Amendments adopt as Additional Designated Exceptions twelve other categories of business relationships that qualify for the PPE without notice or application.14 In each case, the relationship has already been evaluated and approved for the PPE by FDIC staff:
- A property management firm providing property management services;
- An agent or nominee providing cross-border clearing services;
- An agent or nominee providing mortgage servicing;
- A title company facilitating real estate transactions;
- A qualified intermediary facilitating the exchange of properties under Section 1031 of the Internal Revenue Code (“IRC”);
- A broker-dealer for purposes of compliance with Rule 15c3-3(e) (Special Reserve Account) under the Securities Exchange Act or a futures commission merchant for purposes of compliance with CFTC Rule 1.20(a);
- An agent or nominee for placing customer deposits as secure customers’ credit card loans;
• An agent or nominee paying for or reimbursing qualified medical expenses under Section 223 of the IRC;
- An agent or nominee enabling customers to invest in qualified tuition programs under Section 529 of the IRC;
- An agent or nominee enabling customer participation in certain tax-advantage retirement programs under the IRC;
- A government agency delivering funds to beneficiaries of government programs; and
- Other relationships the FDIC specifically identifies in the future as being Additional Designated Exceptions.
IV. Arrangements Requiring a Notice
Under the Amendments, an entity placing deposits pursuant to the PPE under the Payments Exception, or under the so-called “25 percent exception” discussed in Part I of this Client Alert (“25 Percent Exception”), need only file a notice with the FDIC indicating that it is placing deposits in reliance on the PPE.15
V. Arrangements Requiring an Application
Any other entity intending to rely on the PPE other than pursuant to the 25 Percent Exception, Payments Exception, or the Additional Designated Exceptions must file an application with the FDIC.16
The application process is as follows.17 The FDIC will approve applications that demonstrate to its satisfaction that the primary purpose of the third party, with respect to the business line that is the subject of the application, is not the placement, or facilitation of the placement, of deposits. An application for an arrangement on the basis of a proposed primary purpose of encouraging savings, maximizing yield, providing deposit insurance, or “any similar purpose” will be rejected.18 The FDIC can request additional information from an approved entity, and can modify or withdraw its approval if an entity no longer meets the terms of its application.
Date and Timeline for Applications:
- The FDIC will accept new applications beginning on April 1, 2021. It will begin reviewing applications received no later than September 3, 2021. Written determinations will be provided by January 1, 2022 unless the review period for a given application is extended.
- The FDIC will notify an applicant within 45 days of submission if the application submitted was not complete and explain what is needed to complete the application; the FDIC will provide a written determination within 120 days of receipt of a complete application (subject to a potential 120-day extension).
- Either a bank or a nonbank third party that meets the deposit broker definition may apply to the FDIC to be excluded from that definition pursuant to the PPE, but the FDIC generally expects the nonbank third party to apply on its own behalf because it is likely to be in possession of the necessary information for the application.
Content of Applications:
All applications must include, to the extent applicable, at minimum:
- A description of the deposit placement arrangements, including services provided by relevant third parties;
- Descriptions of the business line and its primary purpose;
- Total assets under administration by the third party;
- Total deposits placed by the third party at all banks, including the amounts placed at the bank or banks that are the subject of the application, excluding brokered CDs;
- Revenue generated from the third party’s activities related to the placement or facilitation of placement of deposits, and all third party revenue not so related;
- A description of marketing activities provided by the third party to prospective depositors;
- Reasons the third party meets the primary purpose exception;
- Any other information the applicant deems relevant; and
- Any information the FDIC determines is necessary.
Ongoing Reporting and Monitoring Requirements:
- The FDIC may impose periodic reporting requirements, depending on the proposed arrangement, as part of any written approval.
- A bank accepting deposits from a third party relying on the PPE should be able to access relevant records of the third party.
- If a bank has reason to believe that a third party relying on the PPE no longer qualifies, the bank would be expected to notify the FDIC and begin to report deposits placed by that third party as brokered.
VI. Status of Prior Guidance and Letters
Given that the Amendments significantly alter many aspects of the brokered deposit regulations, the FDIC addressed the ability of industry participants to rely on prior FDIC staff opinions related to brokered deposits. Staff opinions that have not been specifically adopted in the Amendments will be moved to inactive status on the FDIC’s website as of January 1, 2022 and entities will not be permitted to rely on them after that date.19
The Amendments do not specifically address the status of the brokered deposit FAQs. However, given that the FAQs are an amalgamation of staff opinions that will largely be moved to inactive status, it seems likely that the FAQs will also be amended or removed from the FDIC’s website.
VII. Brokered CDs
The FDIC clearly states that brokered CDs will be treated as brokered deposits without exception. The Amendments indicate that brokered CDs were intended to be captured in the brokered deposit definition when the brokered deposit statute was enacted, and assert that brokered CDs have caused significant losses to the deposit insurance fund.20
The full text of the Amendments as posted on the FDIC’s website can be found by clicking here.
Seward & Kissel LLP will continue to provide insight on developments regarding brokered deposits. If you have any questions, please contact Paul Clark, Casey Jennings, or Nathan Brownback in the Washington, DC office at 202-737-8833.