OCC's New Special-Purpose Charter

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OCC’s New Special-Purpose Charter Business Opportunities and Challenges for Fintech and Beyond

Webcast

January 25, 2017

Davis Polk & Wardwell LLP John L. Douglas Lex Sokolin Reuben Grinberg Contact Info

John Douglas Partner – Financial Institutions Group DC: 202-962-7126 | NY: 212-450-4145 [email protected] beyondsandbox.com @DavisPolkReg Reuben Grinberg Associate – Financial Institutions Group 212-450-4967 [email protected]

Lex Sokolin Global Director – Fintech Strategy [email protected] @autonofintech @lexsokolin

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3 Table of Contents

I. Background and Key Considerations II. Implications for Fintech Development and Landscape III. Application to Various Business Models

4 Section I. Background and Key Considerations Background: OCC Special Purpose Charter

. December 2016: OCC proposes special purpose national bank charter . Charter holders must engage in receiving deposits, paying checks, and/or lending money . Same privileges / requirements as full national banks . OCC discouraging applications until publication of OCC policy . Follows a year-long series of OCC innovation initiatives . Not a sandbox OCC releases End of public proposal on comment period OCC White “Receiverships on OCC charter Paper on for Uninsured proposal “Supporting National Banks” OCC releases Sens. Merkley (Jan. 17, 2017) Expiration of Responsible OCC Public OCC releases framework for and Brown send By end of 1Q17: Comptroller of Innovation in the Forum on “Responsible granting special letter opposing Anticipated the Currency Federal Banking “Responsible Innovation purpose national OCC Charter opening of OCC Thomas J. System” Innovation” Framework” bank charters (Jan. 9, 2017) Innovation Office Curry’s Term

March June September October December January March April 2016 2016 2016 2016 2016 2017 2017 2017 Anticipated Issuance of OCC Policy on Special Purpose Charters

6 Background: Comments on OCC Special Purpose Charter

Trade and Consumer State Banking Congress Fintechs Lobbying Advocacy Governments Organizations Members Organizations Organizations

Examples of stakeholder comments:

• Support the charter as long as consumer laws, including predatory • Violates separation of banking and “existing rules and oversight are lending laws), and the states are commerce applied consistent with those for any better positioned to protect consumers • OCC should better coordinate with national bank” • OCC’s proposal would create an ad other regulators • OCC lacks legal authority to charter hoc, confidential regulatory framework • OCC should avoid unnecessary non-depository national banks with unfettered discretion for the OCC, constraints on fintech charter creating an un-level playing field • OCC lacks expertise to evaluate and recipients, and should avoid using supervise fintechs • Charter would distort the market place chartering process to protect national by allowing the OCC to pick winners banks from competition • OCC should engage in a more formal and losers, promoting regulatory cost/benefit analysis capture, or by promoting larger • Charter would hurt consumers established players at expense of (OCC has preempted other state smaller ones

7 Potential Benefits and Considerations: Overview

. Depending on business, financial services companies have three choices: . State-by-state licensing . Structure business to avoid needing a license . Special purpose national bank charter

Benefits: Considerations: . Federal preemption of state licensing requirements . State and federal consumer protections . E.g., money transmitter and lending licenses laws still apply . Federal preemption of state usury laws . CRA / financial inclusion obligations . Avoiding legal uncertainties of the “rent-a-bank” model . Initial and ongoing compliance costs . Legal certainty . Change in business plan must be approved . Management focus . Time to market . Increased business opportunities with partners . A relatively inflexible regulatory environment . A regulatory “stamp of approval” . Required Federal Reserve membership . Potential access to services only open to banks (e.g., . BHC status for parent if deposit-taking access to credit card networks)

8 Potential Benefits and Considerations: OCC Supervisory Requirements and Chartering Process

. Typical national bank supervisory standards and requirements include: . Limitations on activities to those permitted for a national bank (separation of banking and commerce) . Operation likely subject to an OCC-approved business plan over a 3-year horizon and operating agreement (need approval to change) . Other application / chartering requirements: . Pre-filing consultations . Board of directors and management expertise and experience . Robust compliance program (including AML, consumer protection) . Capital and liquidity requirements . Other requirements include data security, privacy and third-party vendor management

“We will require capital, liquidity, sound governance and a robust business plan as a foundation for any company we charter” – Amy Friend, Chief Counsel, OCC

Source: American Banker - Fintech Charter Q&A: OCC Answers Skeptics (Jan. 3, 2017)

9 Potential Benefits and Considerations: Federal Deposit Insurance

. Business of accepting deposits  requires FDIC deposit insurance . Definition of deposit is quite broad – “[T]he unpaid balance of money or its equivalent received or held by a bank or savings association in the usual course of business and for which it has given or is obligated to give credit, either conditionally or unconditionally . . . .” . FDIC deposit insurance requires an application . FDIC will consider and evaluate its own statutory criteria prior to granting insurance . FDIC may attach conditions or limitations . Any FDIC-insured bank is a “BHCA bank” (see next slide)

10 Potential Benefits and Considerations: Bank Holding Company Status Under the BHCA

. Take deposits (other than trust funds)  must obtain deposit Control means much more than actual insurance  under the bank Bank Holding Company Act control: . Any entity that controls a bank under the BHCA – . Own, control or have . must register as a bank holding company, and the power to vote . be subject to regulation and supervision by the Federal Reserve as 25% or more of a such class of voting securities; power to . BHCs are subject to: elect a majority of . enterprise-wide oversight and regulation by the Federal Reserve; the board; or power . strict restrictions on their investments and activities (e.g., may only to exercise a controlling influence engage in certain businesses determined to be closely related to the over management or business of banking); policies . other prudential requirements, including minimum capital and liquidity . Sometimes having requirements; and 5% of voting equity . ongoing reporting and compliance obligations and examination, together with other supervision, and enforcement. indicia can be enough to indicate control Source: American Banker - Fintech Charter Q&A: OCC Answers Skeptics (Jan. 3, 2017)

11 Potential Benefits and Considerations: Membership in the Federal Reserve System

. Must become member of the Federal . Potential Benefits Reserve System . Access to depository accounts . Purchase Federal Reserve bank stock at the Federal Reserve Bank . Additional supervision / regulation by . Direct access to Federal Federal Reserve Reserve operated FMUs . Federal Reserve may impose . Discount window access conditions, restrictions, or limitations as a condition of membership . Based on remarks made by Scott Alvarez, General Counsel of the Federal Reserve . Restrictions on transactions with System, at the 2017 ABA Banking Law affiliates Committee Meeting, the Federal Reserve has not yet decided how access to the discount . Section 23A: limits on extensions of window and payment systems would work for credit by a member bank to its affiliates charter holders and would likely depend on the institution’s purpose, activities and whether it . Section 23B: services must be provided takes deposits. by a member bank to affiliates on market terms

12 Section II. Implications for Fintech Development and Landscape Strategic Assessment of OCC Special Purpose Charter

. Increasing digitization of the financial services industry over last 10 years . Innovation has been effectively outsourced to fintech startups . Current regulatory environment is overlapping and inconsistent . OCC special purpose charter would simplify regime, but is still at odds with how companies are built . Sandbox approach in other jurisdictions align more closely with startup process . Impact of special purpose charter: . Low impact on large incumbents . Medium impact on mid-size banks and credit unions who view regulatory compliance as a competitive advantage

14 Investment in Fintech

$24 Private Investment in Rapid Growth Global Fintech ($ billions) $20.9 $20 $19.1

$16 Private investment in global fintech has $12.1 • $12 increased by 148% in the first half of 2016 over the last year and tenfold since 2010 $8 $4.0 $4 • The U.S., China, and U.K. are the $2.0 $2.1 $2.5 undisputed leaders in Fintech, with $7.3 $0 billion, $2.7 billion, and $901 million, 2010 2011 2012 2013 2014 2015 2016 respectively, raised by fintech companies Google Trends Results: “Fintech” in those countries in 2015

• Banks have invested $7 billion in fintech start-ups from 2010 to 2015

Sources: KPMG The Pulse of FinTech, 2015 in Review (Mar. 9, 2016); Citi Digital Disruption (Jan. 2017); Goldman Sachs, The Future of Finance, Part 3 (Mar. 13, 2015); Law 360, Global VC Fintech Investment Sours 148%, Report Says

15 Framework for Understanding Fintech Innovation

. Patchwork of regulation for a broad ecosystem of fintech startups . OCC charter would make digitization of banking / payments / lending easier

Chatbots

Crowdfunding Roboadvisors Front Office Digitization Neobanks

Neoinsurers

Marketplace

Lending

Open Financial Middle Office Digitization APIs

Data aggregators

Developer Payments Anti-fraud

Back Office Distributed Digitization Ledgers Proximity Proximity client to Smart Contracts

Human Process Machine Process Machine Process Human Intelligence Human Intelligence Machine Intelligence

Source: Autonomous Research

16 Key Difference Between Regulatory Approaches May Lead to Fintech Companies Choosing Sandbox Jurisdictions

Product & Growth & Profitability Ideation Market Fit Scale Optimization

Illustrative number of companies

100,000 10,000 1,000 200

Illustrative time to next stage

12 months 24 months 3 years 3 years

Ideal for sandbox Consumer protection most impactful

. A high capacity for oversight would be needed if thousands of companies attempt to leverage the charter . Full regulatory requirements better fit mature companies that have real market traction

Source: Autonomous Research

17 Key Difference Between Fintech and Small Banks is the Type of Risk They Undertake and How it is Assessed

Established Product Category & Known Economics

New Banks Public Financials

Profits

New Company Large Incumbent Growth

Business model pivots can be Fintech sudden and numerous Series A

Can regulators seed assess early stage risk of this nature?

Source: Autonomous Research Unknown Product & Business Model

18 Comparative Efforts: Comparison of International Fintech Initiatives

. Regulatory Sandboxes . OCC’s Special Purpose National Bank . United Kingdom Charter: . Australia . Not a sandbox: all state and federal . Singapore laws and regulations applicable to . Key Aspects of Sandboxes national banks, including consumer . Regulatory agency chooses laws, still apply participants based on applications . Allows limited activities that are approved as part of application to be undertaken for limited period of time . Competitive Impact on Banks and with limited number of . Low if bank has large scale customers . Waivers or promises of no action on . Medium if bank relies on regulation as certain laws, including consumer barrier to entry protection laws . Agreements between different countries’ regulators can facilitate cross-border sandboxes

19 Section III. Application to Various Business Models Special Purpose Charter More Relevant For…

. Although commonly called the “fintech charter,” the Autonomous Outlook special purpose charter has broader applicability • Partnerships between . Charter is most relevant for: finance incumbents and . Payments tech startups is a leading method of monetization . Lending for early stage investors . Non-U.S. Firms Finance incumbents can . Tech / Retailers • be risk averse and skeptical of tech innovation

• Regulatory compliance in a fintech business may reduce operational and integration risk

• Makes M&A easier

21 Special Purpose Charter Less Relevant For…

. Businesses models that involve licenses or Autonomous Outlook supervision by non-banking regulators, even when engaged in by banks • Although referred to as a . Roboadvisors and personal financial management “Fintech Charter,” the companies OCC’s proposal is a . Insurance providers lending / payments / . Enterprise blockchain banking charter, covering only a part of the fintech . Companies engaged in capital markets activities ecosystem . Businesses that need no licenses, with no clear benefits outweighing costs . Providers of back office, security, compliance or operational enhancements . Companies already regulated as banking organizations in the United States

22 Payments, Virtual Currency Companies, and Prepaid Card

. Preemption of state-by-state money transmitter Autonomous Outlook licensing

. Requirements are complex and often conflict across • Many blockchain states companies operate in the . Licensing process can be time-consuming, costly, grey economy due to uncertain difficulty of becoming legally regulated . Federal BSA / AML laws and economic sanctions administered by OFAC would still apply • Initial Coin Offerings have been trending up as a mechanism for funding

• Creating an onramp that is less onerous could bring this economic activity back into the fold and perhaps generate tax revenue

23 Non-bank / Marketplace Lenders

. Current problems for non-bank market place lenders Autonomous Outlook . Must be licensed in all or most states . Must partner with banks to avoid state-by-state interest • Startups are likely to continue to partner with rate caps established financial firms, . Exportation Doctrine available to banks (i.e., bank’s home since variable costs are state’s usury provisions apply to operations across the U.S.) preferred to the fixed . This “rent-a-charter” model has come under increasing costs and oversight under scrutiny due to recent court cases (e.g., CashCall and the charter Midland Funding) . Benefits of the charter for a marketplace lender • Later stage fintech companies may compare . Preemption of state licensing requirements cost of partnership with a . Preemption of state interest rate caps bank to cost of ownership, . Greater control over destiny and less profit shared with and choose to become a partner banks bank at a certain scale

• Compliance is not a differentiated competitive advantage

24 Non-U.S. Fintech Firms and Non-U.S. Banks that are not BHCs

. Special purpose charter could provide alternative path Autonomous Outlook for non-U.S. fintech firms to enter the U.S. market;

particularly attractive given rapid growth of fintechs in • Innovation centers have Asia and U.K. formed in the U.S., U.K., Singapore, and China . Some may have the advantage of a stable business model, financial strength and experienced • Very few fintech firms management that could possibly qualify for a charter have the option to shop for a regulatory . The complexity of state-by-state regulation of lending environment, but some do and payments activities has been a significant • From a macro deterrent for non-U.S. companies entering the United perspective, it is likely that States regulation quality will decide how successful an ecosystem is, rather than create movement between ecosystems

25 Consumer-Facing Financial and Technology Companies and Retailers

. Large tech companies and retailers are already involved in Autonomous Outlook financial services . Facebook, Google, Microsoft, Apple, Samsung, Amazon: money The large technology transmitter licenses or partner with banks • companies (GAFA) are . Walmart: wide array of services, including prepaid cards. Failed interested in the “attention effort to establish an insured ILC economy,” maximizing . Target: owns an ILC and provides branded prepaid cards issued user engagement in their by insured banks ecosystems . What benefits could special purpose charter potentially offer? • Manufacturing banking . BHC status is a non-starter for these firms. Federal Reserve’s products is unlikely to response unclear given its long-standing history of finding ways further that goal, but the to regulate firms that control banking entities simplified payments . Regulatory benefits (as compared to state licenses) framework could be appealing and save cost . Reputational benefits

. Visa and MasterCard membership • They will avoid regulation . Potential alternative to a credit card bank to the maximum extent possible

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