On December 27, 2019, the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) (together, the Agencies) issued an interagency statement (Statement) to provide supervisory guidance for regulatory expectations for, and to explain that the Agencies will exercise discretion to not take enforcement action against, depository institutions or asset managers that become principal shareholders of institutions with respect to certain extensions of credit by institutions that otherwise would violate Federal Reserve Regulation O.
Regulation O places quantitative limits and qualitative restrictions on extensions of credit by depository institutions to executive officers, directors, principal shareholders and related interests of such persons. The popularity of mutual funds, exchange-traded funds and similar index-based investment products has resulted in several large asset management companies becoming principal shareholders of a number of institutions and has triggered the Regulation O presumption of control of a related interest over an increasing number of companies in the asset managers' portfolios.
The Agencies note that certain banking firms have raised concerns about the application of Regulation O to companies that sponsor, manage or advise investment funds and institutional accounts (collectively, Funds, and, together with the company that sponsors, manages or advises them, Fund Complexes) that invest in voting securities of banking organizations. Over the past few years, Fund Complexes have acquired or have approached acquiring more than 10 percent of a class of voting securities of a wide range of public companies, including banks and non-bank companies. Upon acquiring more than 10 percent of a class of voting securities of a banking organization, a Fund Complex would be a “principal shareholder” of the bank for purposes of Regulation O (Principal Shareholder Fund Complex). Likewise, under Regulation O, any company in which a Principal Shareholder Fund Complex owns 10 percent or more of a class of voting securities could in some instances be presumed to be a “related interest” of the Fund Complex (Fund Complex-Controlled Portfolio Company). In that event, the Principal Shareholder Fund Complex and its Fund Complex-Controlled Portfolio Companies would be considered insiders of the bank under Regulation O. Accordingly, the bank’s lending to the Principal Shareholder Fund Complex and its Fund-Complex-Controlled Portfolio Companies would be subject to the strict lending limits and other restrictions and standards of Regulation O.
Banks have indicated that the treatment of Fund Complex-Controlled Portfolio Companies as “related interests” under Regulation O could require the sudden and disruptive unwinding of substantial pre-existing lending relationships and reduce credit availability to a wide swath of financial and non-financial companies.
While considering whether to amend Regulation O to address these issues, the Agencies state that it is appropriate to articulate supervisory expectations with respect to the application of Regulation O in this specific context in order to provide banks flexibility to lend to certain Fund Complex-Controlled Portfolio Companies, subject to the following eligibility criteria:
(1) With regard to the Fund Complex:
a. The Fund Complex does not directly or indirectly control 15 percent or more of any class of voting securities of the bank;
b. The Fund Complex does not have or seek to have any representative serve as an officer, agent or employee of the bank;
c. The Fund Complex does not exercise or attempt to exercise a controlling influence over the management or policies of the bank, including attempting to influence the dividend polices, loan, credit or investment decisions or policies, pricing of services, personnel decisions, operations activities or any other similar activities or decisions of the bank.
(2) With regard to the bank, the bank does not knowingly make an extension of credit to a Fund Complex-Controlled Portfolio Company, unless the terms of such extension of credit are on substantially the same terms as those prevailing for comparable transactions with unaffiliated third parties and not involve more than normal risk of repayment or present other unfavorable features.
As detailed in the Statement, the Agencies will exercise discretion in not bringing enforcement actions against asset managers and institutions for extensions of credit that would otherwise violate Regulation O, provided the asset managers and institutions satisfy certain conditions designed to ensure that there is a lack of control by the asset manager over the institution. In addition, the FDIC grants no-action relief with respect to otherwise required reporting.