Removing the sovereign-bank nexus should be a priority for policymakers before they press ahead with the European Banking Union.

Some EU Member States argue that the regulatory treatment of government bonds needs to be amended to break the sovereign-bank nexus

 

The European Commission (EC) regards the creation of a full Banking Union as an essential step in making the Economic and Monetary Union (EMU) more stable and resilient to shocks, while limiting the need for public risk sharing. For the EC, the establishment of a European Deposit Insurance Scheme (EDIS) is a critical measure on the road to achieving this. However, in 2016, the Council of the European Union (EU) called for more on risk reduction measures as a precondition for EDIS.

Risk sharing and risk reduction go hand-in-hand and the close financial link between national banking systems and sovereign debtors—the so called "sovereign-bank nexus"—played a key role during the global financial crisis and subsequent eurozone sovereign crisis. Several steps have been taken since to enhance the resilience of both banks and sovereigns and to address the negative spill-over risks between the two, such as the creation of common supervisory and resolution powers. However, the preferential treatment of banks’ exposure to sovereign bonds under the EU’s Capital Requirement Regulation (CRR) so far remains unchanged. Some member countries led by Germany argued that the regulatory treatment of government bonds has to be amended as a precondition of EDIS to break the sovereign-bank nexus.

Current treatment under CRR

Under current regulatory requirements, EU government bonds receive special treatment that applies inter alia to capital requirements and regulation on large exposures.

Banks are required to back their holdings of instruments including government bonds with appropriate levels of equity. The capital requirements are commensurate with the underlying credit risk in line with the objective of ensuring risk sensitivity. Under the Standardised Approach, which relies on external credit ratings, exposures to EU governments are assigned a zero - risk weight. Thus, no equity capital is required for EU government bonds irrespective of the credit rating of an individual Member State. But the Internal Ratings Based Approach (IRB Approach), which relies on banks’ internal rating models, does not automatically result in a zero - risk weight for EU government bonds. Even so, banks using the IRB Approach are also allowed under CRR to assign a zero-risk weight. Firstly, CRR does not provide for a minimum probability of default for sovereign exposures relative to other asset classes. Secondly, the IRB Approach allows banks to apply the Standardised Approach for their exposures to EU government bonds and consequently apply the zero-risk weight.

EU government bonds also receive preferential treatment when it comes to limits on large exposure. Under CRR, exposures to any counterparty are limited to 25 percent of the bank’s own funds in order to avoid risk concentration. However, EU government bonds are exempted from those large exposure limits, allowing a bank to hold government bond exposures that go beyond the stated threshold.

Any adjustment of the regulatory treatment of government bonds needs to be combined with appropriate transitional arrangements

 

Rationale for special treatment of government bonds

The original rationale underpinning the special treatment of government bonds was the assumption that government debts are risk-free because a sovereign debtor is very solvent due to its power to raise taxes and other compulsory levies. In addition, a country’s central bank is generally able to fulfil the government’s commitments denominated in the domestic currency on a potentially unlimited basis.

However, under EMU, the fiscal authorities of Member States have no influence on the European Central Bank’s monetary authority. Furthermore, the "no bailout clause" in the Treaty of the Functioning of the European Union prohibits central bank intervention. While the European Stability Mechanism (ESM) was created to serve as a backstop for euro area countries experiencing, or threatened by, severe financing problems, it cannot fully escape the conclusion that sovereign debts in the euro area are subject to a credit risk.

Another reason put forward to justify the current treatment of government bonds is their particular role in funding public expenditure in the interest of discharging public budgets.

Options for reform

Following the financial crisis, a public debate has emerged about amendments to the regulatory treatment of government bonds to break the sovereign-bank nexus. Due to the potential market effects and the potential consequences for both banks and sovereigns, this issue is regarded as particularly sensitive. EC is awaiting the outcome of the Basel Committee’s review of the regulatory treatment of government bonds. However, the Committee has not yet reached a consensus to make any changes and decided in December 2017 to consult on certain ideas because longer-term thinking on this issue is considered necessary.

The options include the introduction of positive risk weights for sovereign risk exposures. These risk weights could vary depending on the rating of the individual sovereign. Another option would be the introduction of sovereign exposure limits, which would force banks to have a more diversified portfolio of holdings.

Both of these options would have advantages and disadvantages. Positive risk weights would boost capital buffers, thereby increasing the resilience of banks but also their funding costs, while vulnerable countries would pay higher interest rates in order to borrow.

The introduction of exposure limits would encourage banks to diversify their portfolios away from domestic sovereign bonds.

This would help remove distortion and increase incentives for sovereigns to reduce the risk profile connected to their own bonds. However, the attractiveness of sovereign bonds for banks would be reduced, and a large number of banks would be required to decrease their exposure to individual sovereigns and to readjust their sovereign bond portfolio.

Therefore, in order to prevent market disruptions, any adjustment of the regulatory treatment of government bonds needs to be combined with appropriate transitional arrangements such as a grandfathering for the large exposure limits or increasing risk weights over a period of multiple years.

It remains to be seen whether European policymakers will agree to amend the treatment of sovereign bonds under CRR in the interest of further reducing sovereign risks rather than maintaining the current preferential treatment with regard to potential large-market effects including possible reactions in interest rates. Reform of the regulatory treatment could be supported by some financially strong Member States, such as Germany, in order to reduce the level of sovereign risks on bank balance sheets and thus cut the sovereign-bank link. Conversely, countries that would be particularly affected by an amendment of the regulatory framework for government bonds, such as Italy, are likely to resist any changes of the current preferential treatment. However, in view of the current plan to decide on the roadmap to EDIS by June 2018 and the ongoing discussions of the Basel Committee, it is uncertain if amending the regulatory treatment of government bonds will still be considered a precondition for EDIS.

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With fintechs attracting increasing interest from venture capitalists, growth in the M&A activity and partnerships with incumbents, 2018 is shaping up to be the year of the regulators.

It is still unclear which measures the EC will propose to reduce barriers in the single market for fintechs

 

Following a public consultation last year, the European Commission is expected to announce its fintech action plan in February 2018 with a remit to create a more competitive and innovative European financial sector.

The European Commission indicated that it will focus on three core principles—firstly, to enable innovative business models to reach EU scale through technology neutrality so that the same rules are applied to traditionally sold products and services (e.g., via branches) as those sold digitally; secondly, to support the uptake of technological innovation in the financial sector through proportionality so that the rules are suitable for different business models, size and activities of the regulated entities; and thirdly, to enhance the security and integrity of the financial sector to ensure transparency, privacy and security for consumers. It remains to be seen how these will be translated into policy initiatives and legislative actions.

It will be particularly interesting to see which measures the European Commission will propose in order to reduce barriers in the single market for fintechs, e.g., by proposing streamlined authorization and registration regimes for fintechs in EU countries, or EU-wide regulatory sandbox regimes. The European Banking Authority (EBA) identified authorization and sandboxing regimes also as a possible area of future work in its fintech discussion paper.

Data security and cybersecurity concerns were top of the agenda in the consultation, and distributed ledger technology (DLT) is also a point of attention, although it remains to be seen whether this will result in EU-wide regulatory action, or rather in "softer" measures such as the setting up of observatories on the topic and the development of best practices.

In February 2018, the European Commission announced the creation of a EU Blockchain Observatory and Forum to act as a location for building European expertise on blockchain.

Fintechs and financial stability

In 2017, the Financial Stability Board (FSB) issued a report on the potential financial stability implications from fintech. The FSB identified three areas as priorities for international collaboration:

• The need to manage operational risk from third-party service providers
• Mitigating cyber risks
• Monitoring macrofinancial risk that could emerge as fintech activities increase

In the EU, based on the fintech mapping exercise and existing EBA work, the European Banking Authority identified (i) the impact on prudential and operational risks for credit institutions, electronic money institutions and payment institutions; (ii) the impact of fintech on the business models of these institutions; and (iii) the impact of fintech on the resolution of financial firms as possible areas of future work.

We expect an increased focus on outsourcing arrangements and other aspects of fintech that can have an impact on operational risks and financial stability in 2018.

_{February 2018}

EC announced the creation of a EU Blockchain Observatory and Forum for building European experitse on blockchain

 

Artificial intelligence under the microscope

As part of its consultation on fintech in 2017¹, the European Commission asked a number of questions regarding AI, such as:

• Is enhanced oversight of the use of artificial intelligence (and its underpinning algorithmic infrastructure) required? For instance, should a system of initial and ongoing review of the technological architecture, including transparency and reliability of the algorithms, be put in place?
• What minimum characteristics and amount of information about the service user and the product portfolio (if any) should be included in algorithms used by the service providers (e.g., as regards risk profile)?
• What consumer protection challenges/risks have you identified with regard to artificial intelligence and Big Data analytics (e.g., robo-advice)?

The European Parliament carried out a consultation on the future of robotics and artificial intelligence. The results of the consultation will feed into the forthcoming European Parliamentary Research Service’s Cost of Non-Europe on Robotics and Artificial Intelligence Report, and help the European Parliament to address the ethical, economic, legal, and social issues arising in the area of robotics and artificial intelligence for civil use.

We expect further scrutiny by EU and national regulators of the application of AI in general, as well as in the specific fintech context in 2018. It will be interesting to see whether the developments in this area will be limited to "best practices" and soft law recommendations, or will move beyond that to prescriptive, hard law measures.

Towards fintech-friendly jurisdictions

Fintech regulation remains to some extent a national patchwork of various regulations, also within the EU.

It will be interesting to monitor whether national regulations adopt innovative "fintech-friendly" measures to profile themselves as the jurisdiction of choice for forward-looking financial companies.

By way of example, France adopted a pioneering regulation aimed at creating a formal legal framework for the use of blockchain technology for the issuance and transfer of unlisted securities. A further implementing decree will need to be introduced by July 1, 2018.

The dawn of crypto-currency regulation

France’s finance minister, Bruno Le Maire, said at the end of 2017 that he will propose that the G20 group of major economies discuss regulation of the bitcoin virtual currency when it meets in April. The German finance minister, Peter Altmaier, has expressed his support for this proposal, which will include the risks of speculative activities and fraud.

Le Maire also instructed Jean-Pierre Landau, a former French central bank governor, to further investigate the topic of cryptocurrencies and to propose guidelines for the further development of regulation on the topic. Any resulting regulation must be aimed at avoiding tax evasion, money laundering and the financing of criminal activities and terrorism.

These developments are linked to an increased regulatory focus on cryptocurrencies in other parts of the world, such as China and South Korea.

_{May 25, 2018}

The date when GDPR formally comes into force

 

New anti-money laundering rules loom

After lengthy discussions, the European Parliament and the European Council reached an agreement regarding the amendment to the Anti- Money Laundering Directive, initially proposed by the European Commission in July 2016 (AML 5).

The text still needs to be officially endorsed by the Council and the European Parliament before its publication; parliament and council will be called to adopt the proposed directive in the first reading. The publication is expected towards the middle of 2018, with implementation expected by the end of 2019.

AML5 will extend the scope of application of the existing EU anti-money laundering regulations to virtual currency exchange platforms and custodian wallet providers. Virtual currency exchange platforms and custodian wallet providers will have to apply customer due diligence controls, ending the anonymity that could be associated with such exchanges.

For exchanges and service providers already complying with stricter rules applicable in the US or in other jurisdictions, the AML5 requirements will not herald a significant change to their business practices, but rather a need to fine-tune and to be prepared for regulatory enforcement. For other market participants, AML5 will introduce tougher standards, which they will need to start preparing quickly for or risk falling behind.

A crackdown on the "Wild West" for ICOs

In November 2017, the European Securities and Markets Authority (ESMA) issued two statements on Initial Coin Offerings (ICOs), one on risks of ICOs for investors and another on the rules applicable to issuers. ESMA stated that "it has observed a rapid growth in ICOs globally and in Europe and is concerned that investors may be unaware of the high risks that they are taking when investing in ICOs. Additionally, ESMA is concerned that firms involved in ICOs may conduct their activities without complying with relevant applicable EU legislation".

The ESMA statement is confirmation of the idea that ICOs are an "unregulated" form of fundraising is indeed misleading. Instead, these operations require a careful assessment in light of various existing regulations, including applicable existing securities regulations.

In the United States, the Securities and Exchange Commission and the US Department of Justice have indicated that they are actively scrutinizing ICOs, with the SEC starting to bring a number of charges. It remains to be seen whether EU regulators will follow this lead.

The regulation of ICOs is a patchwork. Within the EU, there is no fully harmonized securities regulation, so there is room for diverging approaches. We believe it will be important to continue to monitor the diverging regulatory approaches in the relevant jurisdictions, and it will be interesting to see whether some jurisdictions will develop as "safer" harbors for these types of transactions.

"Data as the new oil" and D-Day for GDPR in 2018

Finally, as the General Data Protection Regulation (GDPR) will formally come into force in the EU on May 25, 2018, the interaction with other regulations (such as PSD2) and fintech activities will be an important area to follow.

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¹—ec.europa.eu/info/sites/info/files/2017-fintech-consultation-document_en_0.pdf

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Virtual currency and blockchain (VC&B) technology are becoming an important component of the global financial system. Although VC&B were founded on a non-governmental philosophy, the technology is steadily gaining legitimacy.

The emerging legal framework is setting the stage for VC&B to be globally accepted in a way not envisioned even a few years ago

 

Global interest in Initial Coin Offerings (ICOs) may have reached a fever pitch last year, but 2017 was also memorable for development of the legal framework that surrounds the use of VC&B, particularly in the US. But the development and legitimization of VC&B also gained momentum in other jurisdictions around the world.

Governments are not only building the legal framework for the commercial and financial use of VC&B, but they are also adopting blockchain-based applications for their own regulatory processes.

While bitcoin developers and virtual currency purists may harbor strong views opposing government intrusion and legal formalities, the emerging legal framework is setting the stage for VC&B to be globally accepted in a way not envisioned even a few years ago. From mainstream consumers to investors, banks and fintech developers, all groups looking to use or develop VC&B products and services can draw comfort from the fact that a legal framework is coalescing, while uncertainty surrounding blockchain technology is disappearing.

A brief history of VC&B

When the pseudonymous Satoshi Nakamoto published Bitcoin: A Peer-to-Peer Electronic Cash System on October 31, 2008, it is unclear whether he/ she envisioned a system designed to alter the role of trusted third parties and government regulators in financial transactions, let alone restructuring the legal framework of the traditional financial system.

Yet, the blockchain or DLT (distributed ledger technology) technology that underpins bitcoin’s defining features—trustless, distributed and immutable—did not take long to migrate to a spectrum of other ubiquitous applications. While change came rapidly, it was not uneventful.

Early on, Bitcoin was often associated with illicit transactions, due in part to the impression that virtual currencies are completely unregulated. While that was initially the case, over the past several years regulators have been creating a legal framework for VC&B. Global initiatives have focused on both the commercial use of VC&B, as well as the use of blockchain technology by governments.

_{US$150 million}

approximate value of the DAO ICO in 2016

 

The US experience

US Federal Guidance

Prior to 2017, there was limited federal guidance relating to VC&B.

In March 2013, the Financial Crimes Enforcement Network (FinCEN) issued guidance that defined virtual currency and interpreted the Bank Secrecy Act (BSA) as applying to exchangers and administrators of virtual currency. Soon after, the US Securities and Exchange Commission (SEC) warned about the use of virtual currencies in the context of Ponzi schemes. A year later, the IRS determined that virtual currency is treated the same as property for federal tax purposes. In a September 2015 enforcement order, the US Commodity Futures Trading Commission (CFTC) defined virtual currency as a commodity under the Commodity Exchange Act.

The most notable VC&B development of 2017 was the SEC’s investigation of the DAO—a decentralized autonomous organization built on the Ethereum Blockchain. The Ethereum Blockchain, like the Bitcoin Blockchain, is processed by a distributed network of computers that are compensated with ETH, the Ethereum currency, for their efforts.

While the DAO operated on the Ethereum Blockchain, it had its own virtual tokens (DAO Tokens) that could be used only within the DAO structure. Its developers capitalized the DAO by launching an ICO that allowed investors to use ETH to purchase 1.15 billion DAO Tokens (worth approximately US$150 million). On June 17, 2016, an attack exploited a flaw in the DAO protocol and diverted more than one-third of the ETH from the DAO’s Ethereum address to one controlled by the attacker. The attack triggered significant fallout within the VC&B community and ultimately led to the SEC investigation.

While the SEC ultimately decided not to pursue enforcement action, it issued a report of investigation last June saying that that federal securities law may apply to ICOs. Specifically, the SEC determined that DAO Tokens are securities under the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act). As such, it determined that the DAO ICO was a securities offering that should have been registered under federal securities laws. In addition, the SEC noted that online platforms that traded DAO Tokens violated section three of the Securities Act by failing to register as securities exchanges. The SEC stressed that its findings would apply to any virtual coins or tokens offered or sold through an ICO with similar facts and circumstances.

US agencies have also played their part in the development of VC&B. In July 2017, the US General Services Administration hosted the first US Federal Blockchain Forum in connection with its Emerging Citizen Technology program. Teams from 27 federal agencies submitted potential cases for blockchain technology use within their organizations. In October, the US State Department hosted the Blockchain@State Forum and discussed the potential for using blockchain technology to boost transparency and accountability within its own department. Meanwhile, the Federal Trade Commission (FTC) continued its efforts to promote the use of blockchain technology in consumer-facing products and services at its third annual FinTech Forum in March.

Other US agencies embraced the possibility that blockchain technology could improve the security of their information-sharing activities. These included proposals and presentations to use blockchain technology to manage and track physical and digital assets, record internal transactions, verify identities, reconcile internal databases and increase interoperability. For example, the US Food and Drug Administration (FDA) formed a joint initiative with IBM Watson Health to research methods for secure, efficient and scalable exchange of health data using blockchain technology. In October 2017, the Centers for Disease Control and Prevention signed an agreement with IBM to expand the FDA initiative and develop a system to use health data on a blockchain to track disease outbreaks.

The Department of Homeland Security, National Aeronautics and Space Administration, the National Institute of Standards and Technology, and the US Department of Veterans Affairs also began to explore the possibility of adopting blockchain-based solutions in 2017, while the US Congress also got involved with the formation of the Congressional Blockchain Caucus to advance public policy on blockchain development. The full embrace of blockchain by US lawmakers and agencies bodes well for the VC&B ecosystem.

_{Aug 1, 2017}

The date when the Delaware law came into force

 

The Delaware law marks a significant step forward for the assimilation of blockchain technology into corporate law

 

State interest and regulation

The US was also active at the state level, including completion of a draft Uniform Regulation of Virtual Currency Business Act (Uniform VCBA) by the Uniform Law Commission (ULC) in July 2017. While US states are not bound by the model law, it is intended to be used as a template for state legislatures seeking to enact virtual currency legislation. The existence of a Uniform VCBA greatly increases the likelihood of a consistent regulatory framework for virtual currencies across all states. The ULC effort reflects information from the New York State Department of Financial Services (NYDFS) BitLicense Regulatory Framework, as well as the Conference of State Bank Supervisors (CSBS) Model Regulatory Framework for virtual currency activities.

The Uniform VCBA focuses primarily on the licensing requirements for companies that host virtual currency exchanges or provide services that involve the transmission of money. The Uniform VCBA would require a licensee to maintain compliance programs that include procedures to prevent fraud, money laundering and funding of terrorist activities. Each US state legislature may consider the Uniform VCBA for adoption, either with changes or as it stands.

Prior to the approval of the Uniform VCBA, a handful of states, including New York, Oregon and Tennessee, enacted legislation defining virtual currency and requiring money transmitters dealing in the exchange of US dollars with virtual currencies to obtain licenses. In 2017, a number of other state legislatures proposed bills to regulate VC&B, as well as to draw VC&B businesses to their jurisdictions. Perhaps the most important state initiative was from Delaware, which amended the Delaware General Corporation Law (DGCL), to allow Delaware companies to maintain shareholder information on a blockchain. Further, Delaware corporations using DLT for their stock ledgers can use that as the basis for their required investor communications.

The Delaware law, which became effective August 1, 2017, marks a significant step forward for the assimilation of blockchain technology into corporate law because it will allow companies to take advantage of DLT for trading without having to maintain duplicate records for corporate law compliance. Supporters of the amendment believe it will keep Delaware at the forefront of corporate law, and that blockchain will improve transparency, reduce settlement times and, thus, will be beneficial to small and large investors alike.

Arizona, Nevada and Vermont also passed laws promoting the use of VC&B and DLT. In March, Arizona enacted a law that defines and supports blockchain technology for public use. In June, Nevada enacted a law recognizing the legality of smart contracts and prohibiting the state from imposing taxes or fees, or other requirements on the use of VC&B. That same month, Vermont implemented a law providing for broader business and legal application of DLT. While not enacting legislation, Illinois was also active, announcing a partnership with identity solutions leader Evernym to use blockchain technology for a birth registration pilot.

While several states passed or proposed stringent licensing regulations on VC&B, other states took a different tack. For example, in July, Connecticut revised its money transmitter licensing law to require companies to obtain a license to engage in transmissions involving virtual currency and established requirements for licensees that store or maintain control over other persons’ virtual currency. By contrast, in June, New Hampshire enacted a law exempting companies dealing in VC&B from registering as money transmitters.

It is clear that state legislators are seriously considering VC&B regulation but frustratingly for developers and users, there is significant variation among state laws. It remains to be seen whether states will adopt the Uniform VCBA.

While issues remain, there are encouraging signs for launching VC&B initiatives

 

Global regulators focus on VC&B

Virtual currencies are by nature borderless, and the rapid growth of VC&B use is an international phenomenon. Bitcoin, for example, has come to rely on mining pools concentrated mostly in China. Governments and regulators in many countries are simultaneously exploring the benefits of VC&B and providing guidelines for its commercial use, all while grappling with the technology’s ability to facilitate cross-border financial crime.

Advancing the use of VC&B – Australia, Europe and Singapore

Australia has been a leader in adopting VC&B and applying DLT, the underlying technology, to its traditional financial system. In 2016, the Australian Stock Exchange (ASX) became the first major securities market to begin testing DLT as a potential replacement for existing settlement systems. During 2017, ASX began running the prototype under the supervision of the Australian Securities and Investments Commission (ASIC), and is expected to announce its decision to move forward with the replacement.

ASIC published Information Sheet 219 (INFO 219) in March 2017, which provided guidance to companies seeking to use DLT to operate market infrastructure or provide financial services. INFO 219 provides six categories of questions that ASIC will use to evaluate any proposed use of DLT. Together, these questions form an assessment tool that firms can use before approaching the regulator in the hope that ASIC will be able to respond more quickly and efficiently. In September 2017, ASIC published Information Sheet 225 (INFO 225) to address the legal status of ICOs in Australia. Although it did not stem from a possible enforcement action as ICO guidance did from its US counterpart, INFO 225 addresses many of the same issues. The ASIC notes that, depending on characteristics of a particular offering, an ICO could be considered as a share offering, a derivatives transaction, or a managed investment scheme. Under Australian law, each of the above are defined as a financial product and the platforms that enable investors to buy and sell such coins would need to hold an Australian market license.

Australia is also supporting VC&B development by actively studying and promoting potential uses of DLT. In May 2017, the Australian National Innovation Science Agenda and the Treasury sponsored two reports by the Commonwealth Scientific and Industrial Research Organisation (CSIRO).

The first report focused on case studies for DLT implementation to identify current limitations and make recommendations. The second report highlights where Australia intends to take DLT over the longer term. In Distributed Ledgers: Scenarios for the Australian economy over the coming decades, CSIRO frames the discussion around what the economy and the world might look like in 2030. Australia views DLT as essential to its future prosperity and competitiveness, and the country believes that a strong partnership between the government and private sector is the only way to fully develop the technology.

In September 2017, the European Central Bank’s Advisory Group on Market Infrastructures for Securities and Collateral released a report on the potential impact of VC&B on harmonization and integration. The ECB report covers three categories where DLT could be implemented—financial market infrastructures; securities settlement and related services; and security and data protection. The ECB report encourages further development of DLT and sees a positive long-term impact from VC&B. It also highlights the potential for DLT to reduce settlement times, streamline collateral management, improve the cyber resilience of financial networks, and develop tokenized digital identities for strengthening AML systems.

In October, the Monetary Authority of Singapore (MAS), one of the leading international regulatory proponents of the opportunities presented with VC&B and DLT, jointly announced with the Association of Banks in Singapore (ABS) that a consortium they are leading through their Project Ubin had "successfully developed software prototypes of three different models for decentralized inter-bank payment and settlements with liquidity savings mechanisms." The project uses DLT for clearing and settlement of payments and securities, and incorporates three software models that are among "the first in the world to implement decentralized netting of payments in a manner that preserves transactional privacy."

International organizations provide legitimacy

In 2017, a number of international organizations also moved toward establishing standards for VC&B and the development of DLT. In late 2016, the International Organization for Standardization (ISO) established Technical Committee 307 to develop standards for blockchain and DLT. The inaugural meeting of the Technical Committee was held on May 24, 2017, in Sydney, Australia, and was attended by representatives from more than 45 countries. Of these, 25 participating countries designated ISO/AWI 22739 as the first standard to be developed to establish uniform terminology and concept descriptions. Although this is a relatively prosaic step, it represents a dramatic change in perception for VC&B. International organizations are working to bring DLT into the legal mainstream less than a decade after Bitcoin’s emergence as an alternative to the traditional financial system.

In addition to the Terminology working group developing ISO/AWI 22739, the Technical Committee has five subcommittees focused on: (1) reference architecture, taxonomy and ontology; (2) use cases; (3) security and privacy; (4) identity; and (5) smart contracts. The goal is to develop standards that are "robust enough to provide guidance to stakeholders and potentially be referenced by regulators in policy," but are technical and "exclude matters pertaining to the law in the development of standards for smart contracts, privacy, security and identity."

The European Parliament also sought to address VC&B issues during 2017. An in-depth analysis published in February 2017 by the Scientific Foresight Unit (STOA) of the European Parliament Research Service sought to identify how blockchain technology would impact the Member States at a societal level. STOA identified the potential for DLT to improve everything from voting to tracking digital media online and from commercial contracts to supply chain logistics. In calling on the European Parliament to engage in anticipatory policymaking, STOA notes that, "the decentralized, cross-boundary character of blockchain raises jurisdictional issues as it seems to diffuse institutional accountability and legal responsibility in an unprecedented manner, rendering the need for a harmonized regulatory approach at the transnational level more pertinent compared with a local or regional one."

_{US$6 billion}

total amount raised by ICOs in 2017 globally

 

Global regulatory attention on ICOs

Following the SEC’s July Bulletin regarding ICOs, financial and securities regulators from many other countries issued their own guidance or alerts. The reaction is not surprising considering more than US$6 billion was raised by ICOs in 2017. Australia’s ASIC responded to rapid ICO expansion with detailed guidance for when an ICO would be regulated. In contrast, the National Internet Finance Association of China (NIFA) published a notice on August 30, 2017 warning of the risks associated with ICOs. Five days later, on September 4, 2017, through a joint notice interagency issuance, China effectively banned ICOs. The notice also banned the trading and exchange of tokens and coins between one another.

Also in September, the UK’s Financial Conduct Authority (FCA) issued its own warning regarding ICOs, stating that "ICOs are very high-risk, speculative investments," and listing the risks associated with ICOs. The FCA noted that whether or not an ICO falls under its jurisdiction is a case-by-case determination. Similar bulletins were issued by other national regulators, including in Singapore, Canada and Hong Kong.

Efforts ramped up but issues remain

In 2017, VC&B development and regulation had a number of important advances. Globally, regulators and international standard-setting bodies have ramped up efforts on VC&B, but many issues remain. And the potential for enforcement actions by financial crime prevention agencies remains untested. While the outstanding questions are important, businesses, financial institutions and governments that have been hesitant to launch VC&B initiatives should see encouraging signs. A regulatory framework has taken shape in 2017, and is providing a foundation for building a path to mainstream acceptance and legitimacy of DLT and the application of VC&B use cases.

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A raft of regulatory changes, both domestic and EU-related, is reshaping the Polish banking market. As the biggest economy in Central and Eastern Europe, any changes to its banking system will have an impact on the rest of the region. Here we explore some of the most important changes.

For the past few years, FX loans have been one of the most talked-about topics on the Polish economic and political landscape. According to the data of the Polish Financial Supervision Authority (PFSA) from July 2017, approximately 40 percent of the outstanding PLN 396 billion (approximately €94 billion) consumer mortgage loans granted by Polish banks are denominated in foreign currencies (mainly Swiss francs).

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Several banks are considering opening new mortgage units, sending a clear indication that the market is destined for growth

 

During the mid-2000s, immediately after Poland’s entry into the European Union, there was a proliferation of mortgage loans denominated in foreign currencies due to significantly lower interest rates. Since then, the Polish Financial Supervision Authority has restricted the granting of new loans (since 2013 Recommendation S only allows banks to loan to individual customers in the currency in which the customer obtains the majority of his/her income).

While both the current and previous governments have publicly indicated their willingness to introduce legislation that would relieve some of the burdens of FX loans (indeed going as far as proposing a forcible conversion of the existing FX loans into zloty-denominated loans), the only legislation passed to date is the 2015 Act on Assistance to Borrowers in Difficult Financial Situations who Took a Residential Loan (the "2015 Act"). The impact of the 2015 Act has been rather limited, as it only provides assistance to borrowers who are unemployed (with certain exceptions), have very low income or for whom the costs borne in connection with the loan exceed 60 percent of the income of their household. Furthermore, the duration of the assistance in the form of repayment of installments in an amount not higher than PLN 1,500 (approx. €350), per month by the state-run Bank Gospodarstwa Krajowego, cannot exceed 18 months.

However, the changes in the regulatory approach did not affect existing loans. In the meantime, a significant increase in the value of the Swiss franc relative to the Polish zloty (while currently CHF 1 is valued at ca. PLN 3.6), in the heyday of CHF-denominated loans, CHF 1 was worth ca. PLN 2.00 combined with a reduction of the value of some of the real estate underpinning the mortgage loans and has resulted in significant problems for some borrowers whose installments are nearly twice as high as at the time of the conclusion of the loan agreement. At the same time, several banks have ended up with significant portfolios of potentially distressed assets.

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Critics of the 2015 Act say it does not resolve the structural issues associated with FX loan portfolios, but instead focuses on providing short-term relief for borrowers whose financial situation has rapidly deteriorated. In order to address the broader FX loan issue, numerous proposals have been introduced by members of parliament. However, the only legislative proposal that currently appears to have a realistic chance of being passed was presented earlier this year by Polish President Andrzej Duda (the "Draft Act"). The Draft Act contains the following restructuring and assistance mechanisms:

• Assistance in the form of repayment of installments by the state-run Bank Gospodarstwa Krajowego has been increased to 36 months
• The debt-to-income ratio allowing assistance to be obtained has been cut to 50 percent
• In the event the proceeds obtained from the sale of mortgaged property do not cover the entire amount of the loan (in general Polish legislation does not provide for non-recourse loans), the borrower would be able to obtain preferential loans from the state-run Assistance Fund to repay the outstanding part of the loan

In the event of voluntary restructuring of an FX loan into a zloty loan, the Restructuring Fund would cover the difference between the balance sheet value of the FX loan prior to restructuring and the restructured zloty loan.

While some observers say the above proposals are still not fully adequate, they are more far-reaching than the original legislation. In particular, the provisions that allow the Restructuring Fund to cover the "loss" of the lender resulting from the loan conversion could be a satisfactory solution for both lenders and borrowers.

The PFSA is working on a new recommendation which, while not formally binding, would strongly compel banks operating in Poland to restructure FX loans on a voluntary basis and allow borrowers to convert them into zloty-denominated loans, which combined with the "loss coverage" provisions, could provide a long-term solution.

_40%

Of consumer mortgage loans in Poland are denominated in foreign currencies
Source: Polish Financial Supervision Authority

Changes to the Polish covered bonds landscape

The 1997 Polish Act on Covered Bonds and Mortgage Banks (the "Covered Bonds Act") recently celebrated its 20th anniversary. Until recently, the Act, which creates the legislative framework for the operation of specialized mortgage banks, the only entities allowed to issue covered bonds under Polish law, has been of rather limited use. However, changes introduced in the last two years have reinvigorated the market, and led to the establishment of international covered bond programs by Polish banks, such as PKO Bank Hipoteczny S.A., which established a €4 billion programme in 2016 and mBank Hipoteczny S.A., which announced a €3 billion programme a year later. The main changes include:

• Mandatory overcollateralization to the amount of 110 percent
• A mandatory liquidity buffer amounting to at least the interest payable on covered bonds over a period of six months
• Easier refinancing of residential mortgage loans (up to 80 percent of the mortgage lending value)
• Introduction of a new procedure in case of the bankruptcy of a mortgage bank, including the introduction of a pass-through model in the event of a mortgage bank’s bankruptcy (essentially under certain circumstances, the holders of the covered bonds are repaid directly from the proceeds from the underlying covered bonds)
• Increase of the ability of pension funds to invest in covered bonds.

From the perspective of the economic viability of an investment in covered bonds, the exemption of interest on covered bonds from withholding tax since the start of 2016 is a particularly welcome measure. Since the first international issue of Polish covered bonds in October 2016 by PKO Bank Hipoteczny S.A., the product has been a resounding success (all existing issues were significantly oversubscribed, and the first issue was oversubscribed by 200 percent).

Given the overwhelmingly positive feedback, other big market players are looking at the possibility of opening mortgage banks, including ING, which has already obtained a license in January 2018, and Bank Zachodni WBK (Santander group), which is in the process of obtaining one.

The benefits of the new legislation are self-evident. The creation of additional regulatory restrictions, such as mandatory overcollateralization and liquidity buffers along with new bankruptcy procedures, means that international investors now regard Polish covered bonds as a safe product. From a borrower’s perspective, increasing a mortgage bank’s ability to refinance mortgages (and consequently to increase their cover pool) while reducing the tax burden has made the product economically viable. The fact that several key players in the market (including non-Polish banks) are considering opening new mortgage banks is a clear indication that the market is destined to grow.

Changes introduced in the last two years have reinvigorated the Polish covered bonds market

 

New mortgage credit regulations

In July 2017, a new act on mortgage credit and supervision over intermediaries and agents entered into force in Poland. The Mortgage Credit Act introduced a number of new rules for credit institutions granting mortgage loans, aimed at protecting borrowers who are consumers (the legislation does not affect loans granted to businesses).

While the Mortgage Credit Act transposes Directive 2014/17/EU on credit agreements for consumers relating to residential immovable property into Polish law, it also introduces several concepts specific to the Polish market. First, the new Mortgage Credit Act formally codifies the restriction on the granting of FX loans first introduced in Recommendation S in 2013 by the Polish Financial Supervision Authority. According to the Mortgage Credit Act, a mortgage loan can be granted only in a currency or indexed to a currency in which the consumer gains most of his or her income or holds most of his or her funds or other assets. Second, the Mortgage Credit Act limits the ability to grant mortgage loans to banks (including EU credit institutions and Polish branches of non-EU banks) and credit unions. As a result, non-banking lenders will no longer be able to grant mortgage loans to consumers. Furthermore, the provisions of the Mortgage Credit Act introduce a register of credit intermediaries maintained by the PFSA, and also set out the scope of supervision over the economic activity of mortgage credit intermediaries and agents. The changes in the Polish banking sector are substantial, and they are hapenning at a great pace, but will they be good for the country’s economy? Only time will tell.

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The financial services industry is undergoing a radical transformation. Companies that can navigate this uncertain terrain will retain a competitive edge.

European Leveraged Finance Alert Series: Issue 2, 2018

Following the release of White & Case’s 4th annual EMEA Leveraged Finance Report in January, this Alert discusses certain key legal issues when structuring leveraged finance deals in France, where a total of over €65 billion of loans and €14 billion of bonds were issued in 2017.

Upstream Credit Support

One of the principal legal issues impacting the structuring of debt financings in France is the restrictions on granting upstream credit support.

Corporate Benefit

The granting of guarantees by French subsidiaries of the debt of their French parent/sister companies raises significant legal issues. First, under French corporate benefit rules, a company is required to use its assets and credit solely to further its own corporate purposes and for its own benefit (or that of its subsidiaries). The granting of an upstream/cross-stream guarantee by a French subsidiary would violate this rule if that subsidiary cannot demonstrate that it derives a benefit from the guarantee. The chairman, the directors and other executives may be exposed to civil sanctions (on grounds of mismanagement) or even criminal sanctions (on grounds of misuse of the corporate assets or credit of the company or breach of confidence) for failure to comply with these requirements and the guarantee or security may be nullified by French courts.

In order to minimize the risk that an upstream guarantee would violate this rule, the market practice is to contractually limit the guarantee obligations of the French subsidiary guarantor to an amount equal to the amount of the proceeds of the guaranteed parent/sister company debt (whether under a facility or debt securities) that is directly or indirectly on-lent to that guarantor by the parent/sister company borrower under intra-group loans and that is outstanding from time to time. The on-lent proceeds are considered to represent the benefit received by the subsidiary guarantor in exchange for the guarantee that it grants up to the amount of such proceeds. If no proceeds from a parent/sister company borrowing are on-loaned to a particular subsidiary (as in the case where that subsidiary has no debt that needs to be refinanced with such proceeds), any guarantee of such parent/sister company borrowing by that subsidiary would be potentially legally voidable.

Financial Assistance

French financial assistance rules pose another obstacle to the granting of upstream guarantees by French subsidiaries. A company incorporated as a société par actions (SAS or SA) cannot advance funds, grant loans or grant security interests or guarantees of debt incurred by a third party to finance the purchase of the shares of that company or any of its parent companies. Guarantees or security interests granted in breach this rule may be nullified by French courts and may even invite criminal sanctions. Therefore, if an entity is acquiring a French SA or SAS, it is not possible for the latter or any of its subsidiaries to guarantee the debt incurred by the acquiring entity to finance the acquisition.

Interest Deductibility

Another consideration in the structuring of upstream credit support in French issuer/borrower deals stems from French thin capitalisation rules related to interest deductibility. Although not strictly an obstacle to the granting of upstream credit support, these rules may limit the tax deductibility of interest on debt of a French borrower/issuer that is guaranteed by related parties (including subsidiaries). According to Article 212 of the French Tax Code ("FTC"), restrictions on interest deductibility apply to interest on debts of any kind due by one corporate entity to another if these entities are related within the meaning of Article 39-12 of the FTC – i.e., when there is a subordination relationship between them. Article 212 II of the FTC provides that, subject to certain exceptions, a loan extended by a third party to a French borrower would be treated as a loan granted by a related party for tax purposes ("tainted debt") if it is directly or indirectly guaranteed by a related party such as a subsidiary. Therefore, to the extent that the debt of a French company is guaranteed by its subsidiaries, that debt is subject to thin capitalisation limitations on interest deductibility. Loans extended to refinance outstanding borrowings that become due because of a change of control of the borrower are not caught by the thin capitalisation rules.

In the case of tainted debt, the amount of interest that would be deductible is capped at the highest of the three following cumulative limits: (i) the interest on such debt to the extent such debt does not exceed 1.5 times the borrower’s net equity, (ii) 25% of readjusted current profit before tax and (iii) the amount of interest received by related parties. In practice, if the debt-to-equity ratio of the borrower is lower than 1.5 to 1.0, the full amount of interest will be deductible. Non-deductible interest can be carried forward with a discount of 5% each year and deducted during the following fiscal years when the company is no longer thinly capitalised. Net interest expenses that remain deductible after application of thin capitalisation rules are deductible only up to 75% of their amount, if they are higher than €3 million.

Taking Security in France

The concept of floating charges or other all-assets security arrangements does not exist in France. Therefore, security has to be taken on an asset-by-asset basis. In French leveraged finance transactions, the most commonly taken security is over shares (and other securities), receivables and bank accounts. Other assets (including intellectual property, inventory or ongoing business) can also be included in the security package on a case-by-case basis. For reasons relating to cost, security is not usually taken over real estate. Perfection formalities (e.g. dispossession of the pledged asset, registration, notification) would depend on the type of security interest and the nature of the pledged asset.

In a typical English law secured financing, the security agent acts on trust for the creditors to whom the secured liabilities are owed. However, English law trusts are neither recognized nor enforceable in France. Several years ago, the French law trusts regime was created but not sufficiently utilized because of the burdensome nature of, inter alia, registration and transfers required in the context of a syndicated financing. Nonetheless, due to recent changes in French law, it is now possible to appoint a security agent pursuant to a simplified security agent regime in order to take and enforce security for the benefit of the creditors of the secured obligations.

Before such changes to French law were enacted, the pledgee of a security interest under French law and the creditor of the claim secured by that security interest had to be the same person and security could not be created in favour of a security agent that was not itself a direct creditor of the secured liabilities. For this reason, finance documentation for French borrowers/issuers sometimes provided for the creation of English law "parallel debt" obligations in favour of the security agent which mirrored the obligations of the underlying debt owed by such borrower/issuer. The parallel debt had the same principal amount and was payable at the same times as the underlying debt, and any payment on the underlying debt would discharge the corresponding obligation under the parallel debt (and vice versa). Any French law pledge would secure the parallel debt and not the underlying debt. Such parallel debt structure can still be implemented in transactions where the security agent does not act pursuant to the simplified security agent regime described above.

Creditors’ Committees

French law bankruptcy considerations may also influence the structuring of financings by French borrowers/issuers. In general, in the event of a French law safeguard (sauvegarde) or rehabilitation (redressement judiciaire) proceeding opened in respect of a French company, the creditors of the relevant company will be grouped by the court-appointed administrator (on the basis of the claims that arose prior to the judgment commencing the proceedings) into the following creditors’ committees and bodies:

• one committee for credit institutions or similar institutions and other entities that have made loans or advances to the debtor (or acquired loans or advances owed by the debtor), including entities that are sponsor affiliates (the "credit institutions committee");
• one committee for suppliers having a claim that represents more than 3% of the total amount of the claims of all the debtor’s suppliers and other suppliers invited to participate in such committee by the court-appointed administrator (the "major suppliers committee" and, together with the credit institutions committee, the "creditors committees" and each a "creditors committee"); and
• if there are any outstanding debt securities (such as bonds or notes), bondholders vote not in a committee but pursuant to a single general meeting of all holders of such debt securities (the "bondholders general meeting").

For a proposed plan to be adopted, it must be approved by creditors on each creditors committee and the bondholders general meeting representing two-thirds of the total outstanding liabilities of all creditors on such creditors committees and bondholders general meeting. All creditors on each creditors committee or the bondholders general meeting vote on a one-euro-one-vote basis regardless of any differences in rankings and security as between the claims of such creditors and whether or not the voting creditor is an affiliate of the borrower/issuer, provided that the proposed plan must take into account any subordination agreement entered into prior to the opening of the safeguard or rehabilitation proceedings.

Because of the treatment of voting rights in the context of French safeguard or rehabilitation proceedings, the lenders in a leveraged financing by a French company would typically seek to ensure that they have a two-thirds voting majority on the credit institutions committee at all times. To this end, the contractual documentation governing the financings would usually restrict the ability of sponsors and members of the borrower group to become creditors of indebtedness owed by members of the borrower group. This is accomplished by either limiting the amount of such indebtedness that can be owed to such entities or by structuring sponsor or intra-group debt in the form of bonds (if the underlying debt is in the form of bonds, and vice-versa), thereby relegating the sponsor and intra-group creditors to the bondholders general meeting (if the relevant financing is bank debt) or the credit institutions committee (if the relevant financing is bond debt). In addition, in bond financings involving side-by-side senior secured and senior subordinated tranches, limits on redemptions may be contractually imposed to ensure that the senior secured tranche represents at all times at least two thirds of the total amount of outstandings under all bonds and notes issued by the issuer.

Contractual agreements relating to the exercise of the votes in committees have recently been recognized under French law. Under legislation adopted in 2014, each member of a creditors committee or of the bondholders general meeting must, if applicable, inform the court appointed administrator of the existence of any agreement relating to (i) the exercise of its vote or (ii) the full or total payment of its claim by a third party as well as of any subordination agreement. The court-appointed administrator would then make a proposal for the computation of its voting rights in the relevant creditors committee/bondholders general meeting. In the event of disagreement, the matter may be ruled upon by the president of the Commercial Court in summary proceedings at the request of the creditor or of the court-appointed administrator. Therefore, there is a greater likelihood today that the voting arrangements set out in intercreditor agreements, for instance, governing creditors’ respective rights under a particular financing will be recognized in a French safeguard proceeding. Nonetheless, the above-described practices of restricting the ability of sponsors or group members to become creditors of the issuer/borrower or of requiring certain intra-group loans to take the form of bonds is still current in the French market.

Other topics may be relevant for the purposes of structuring debt financings in France (e.g. banking monopoly).

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Global law firm White & Case LLP has advised a bank syndicate led by BNP Paribas, HSBC, J. P. Morgan and UniCredit on the €275 million high yield bond issuance by Nordex, a wind turbine manufacturer.

The high yield bond has a maturity of five years and a 6.5% coupon rate. The proceeds from the placement will be used for the early repayment of existing liabilities. The bond is certified as a ‘Green Bond’ by the Climate Bonds Initiative.

The White & Case team which advised on the transaction was led by partner Rebecca Emory (Frankfurt) and included partners Gernot Wagner, Karsten Woeckener, Vanessa Schuermann, Lutz Kraemer (all Frankfurt), Karl-Jörg Xylander (Berlin) and Bodo Bender (Frankfurt), local partners Sebastian Schrag, Florian Ziegler, Cristina Freudenberger and Thilo Diehl (all Frankfurt), counsel Alexander Born (Frankfurt) and associates Mansha Malhotra, Eva Maryskova, Irina Schultheiss, Justin Tevelein, Kirsten Donner and Tobias Gans (all Frankfurt). Lawyers from White & Case offices in the UK, Italy, France, Sweden, Singapore, Spain, Mexico, South Africa, Turkey and the US also advised.

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Pratin Vallabhaneni is a partner in White & Case's global Banking and Financial Institutions Advisory practices. He represents both US and non-US fintech, banking, broker-dealer, exchange, insurance, asset management and specialty finance companies, as well as their directors, senior officers and investors, on transactional, enforcement and regulatory matters. Clients often call upon Prat to strategically navigate cutting-edge fintech issues that are complex, rapidly evolving and multijurisdictional in nature.

Prat's transactional practice focuses on public and private M&A, capital raising, bank finance, commercial agreements and activism matters. Prior to joining the firm, Prat was an investment banker at Morgan Stanley, where he advised clients on valuation and execution of M&A, capital markets, bank finance, securitization, activism defence and restructuring mandates.

Prat's financial regulatory and enforcement practice focuses on advising financial services clients on matters before the Federal Reserve, OCC, FDIC, SEC, CFTC, CFPB, FTC, Treasury Department, FinCEN, OFAC and state banking and securities agencies. Earlier in his career, Prat served as an attorney at the FDIC during the global financial crisis where he worked on numerous crisis-related, private equity-backed bank M&A transactions, bank receiverships and enforcement actions against banks, consumer finance firms, and directors and officers. He was also actively involved in the interagency implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Global law firm White & Case LLP has expanded its Global Banking Practice with the addition of Pratin Vallabhaneni as a partner. Vallabhaneni will work closely with the Firm's Global Financial Institutions Advisory Practice and will advise clients on complex fintech-related issues.

"The proliferation of mobile banking, online financial services platforms and blockchain technologies is rapidly changing the banking and broader financial services industries, with no sign of abatement," said Eric Leicht, Head of White & Case's Global Banking Practice. "Prat will further raise our profile with both traditional and nontraditional banks and financial service providers that are at the cutting edge of adopting and developing these innovative technologies."

Vallabhaneni represents fintech, banking, broker-dealer, exchange, insurance, asset management and specialty finance companies, as well as their directors, senior officers and investors, on transactional, enforcement and regulatory issues and on matters before the Federal Reserve, OCC, FDIC, SEC, CFTC, CFPB, FTC, Treasury Department, FinCEN, OFAC and state banking and securities agencies.

"Prat will be a valuable resource for our clients that are looking for ways to improve the delivery of their products and services through the use of new technologies," said Jake Mincemoyer, White & Case's Regional Section Head, Americas Banking. "His addition also gives us greater capabilities to address the business and enforcement challenges that financial institutions are facing, which are oftentimes novel, rapidly evolving and multijurisdictional."

Vallabhaneni, who joins the Firm from Arnold & Porter, also represents US and non-US companies across a variety of industries that operate in or hold exposure to the financial services sector and provides them broad transactional counsel on bank financing, capital raising, public and private M&A, commercial agreements and shareholder activism matters.

Vallabhaneni was previously an investment banker at a global financial services firm, where he advised on the valuation and execution of M&A, capital markets, securitization and restructuring mandates. Prior to that, Vallabhaneni served as an attorney at the FDIC during the global financial crisis. There he worked on numerous crisis-related private equity-backed bank M&A transactions, bank receiverships and enforcement actions against banks, consumer finance firms, and directors and officers. Vallabhaneni also was actively involved in the interagency implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

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Global law firm White & Case LLP advised PFH on its acquisition of Uni Gasket Group.

PFH is an independent investment holding company which has been operating in Italy for more than 30 years. Uni Gasket is an Italian company active in the production of PTFE, rubber and silicone pipes and gaskets.

The transaction has been partially financed through a term and revolving facility agreement provided by Unione di Banche Italiane S.p.A. and Banco BPM S.p.A., which were also advised by White & Case.

The White & Case team in Milan which advised PFH on the transaction comprised partners Leonardo Graffi and Veronica Pinotti, associates Alessandro Seganfreddo and Fabrizia Faggiano and lawyer Luca Silviani. The team which advised the banks comprised partner Iacopo Canino and associate Adriana Tisi.

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White & Case partners Kevin Petrasic, Benjamin Saul and George L. Paul (Washington, DC), and Steven R. Chabinsky (New York), have been named recipients of the 2018 Law360 Distinguished Legal Writing Award, formerly known as the Burton Award, which recognizes outstanding legal writing published in the prior year. White & Case has won a Burton Award every year since 2001, and remains the only firm to be recognized consistently for the past 17 years.

Petrasic, Saul, Paul and Chabinsky were honored for their article "Managing AI Risk in Financial Services," published by Bloomberg BNA Privacy & Security Law Report, August 21, 2017.

The awards are run in association with the Library of Congress, presented by lead sponsor Law360 and co-sponsored by the American Bar Association. Winners were selected by an expert panel from nominations submitted by the 1,000 largest law firms in the United States, and will be formally presented with their Law360 Distinguished Legal Writing Awards on May 21.

William Burton, Founder and Chair of the awards program, said "The winners are outstanding, highly skilled, and effective writers, and the competition was acutely keen. The Law360 writing award winners have now attained a new and even higher standard of excellence.

Global law firm White & Case LLP has advised the European Investment Bank (EIB) on a strategic €550 million financing to ORES, one of Belgium's main gas and electricity distribution networks operators.

The financing will be used to make the network greener and more efficient. Brussels-based White & Case local partner Hadrien Servais, who co-led the Firm's deal team said: "White & Case has been advising the EIB on important transactions of this nature for a number of years, and this deal is another demonstration of the strength of our relationship."

The White & Case team in Brussels which advised the financing was led by local partner Hadrien Servais and counsel Willem Van de Wiele, with support from associates Aurélie Terlinden and Eline Souffriau.

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Global law firm White & Case LLP has advised J.P. Morgan, as mandated lead arranger and agent, on the financing of ADLER Real Estate AG's acquisition of up to 70 percent of Brack Capital Properties N.V. (BCP), a public limited liability company incorporated in the Netherlands and listed on the Tel Aviv Stock Exchange with total assets amounting to around €1.6 billion.

ADLER has entered into a share purchase agreement with Redzone Empire Holding Limited for the acquisition of a 41.04 percent stake in BCP. In addition, members of senior management at BCP have irrevocably undertaken to tender their respective shareholdings of a combined 5.62% in ADLER into the so called special tender offer (STO), which ADLER has launched for the purpose of acquiring up to 25.8 percent of the shares in BCP. In total, ADLER is thus targeting a shareholding of up to 70 percent. On the assumption that the maximum number of shares will be tendered, the acquisition volume amounts to around €539 million.

BCP owns a real estate portfolio of more than 11,000 residential units in Germany, of which two thirds are located in prime locations. The portfolio is concentrated in major German cities, among them Leipzig (30 percent), Bremen (ten percent), Dortmund, Hannover and Kiel (nine percent each), overlapping with the existing ADLER portfolio.

The acquisition and the STO will be financed from existing cash in ADLER, the proceeds from the recent sale of its stake in ACCENTRO Real Estate AG and the sale of non-core residential assets in ADLER. These amount to a total of around €350 million. The balance funds are provided under an in-place bridge loan financing agreement entered into with J.P. Morgan.

The White & Case team which advised on the transaction was led by partners Jacqueline Evans (London) and Thomas Flatten (Frankfurt), and included partner Philip Broke (London) and associates Julian Brun, Nigela Houghton (both London) and Tobias Daubert (Frankfurt).

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The new federal tax rules (informally known as the Tax Cuts and Jobs Act ("TCJA")), signed into law on December 22, 2017, significantly expand the situations in which a foreign corporation will be treated as a "controlled foreign corporation" (a "CFC") and expand the types of income of the CFC that certain US shareholders must include annually on their tax returns. In particular, foreign corporations that are owned by a foreign parent might now be CFCs if the foreign parent also directly or indirectly owns at least one US corporation or if the foreign parent has an owner that also directly or indirectly owns a US corporation. As a result of this expansion, many US shareholders who were not previously affected by the CFC rules are now subject to annual income inclusions. In addition, there is now a new tax (the "GILTI" tax) imposed on US shareholders who hold an interest in a CFC. Thus, many US shareholders who were previously subject to the CFC rules are now subject to additional annual income inclusions. Some of these changes are effective for the 2017 tax year.

Expansion of CFC Regime

In order for a foreign corporation to be treated as a CFC, more than 50% of the stock of the foreign corporation must be owned, directly or indirectly, by one or more US persons who own at least 10% of the stock of the foreign corporation (such 10% or greater US shareholder, a "US Shareholder"). Two changes made by the TCJA expand the situations in which a foreign corporation will be treated as a CFC.

"Downward Attribution"

The change that is likely to have the broadest application is the change to the so-called "downward attribution" rule. Prior to the change, an "owner" of stock of a foreign corporation (for purposes of testing whether US Shareholders own more than 50% of a CFC) generally had to be a direct or indirect shareholder of the foreign corporation. As a result of the change to the "downward attribution" rule, a sister company to the foreign corporation is now treated as an "owner" of the foreign corporation. This is because under the new "downward attribution" rule, the stock owned by a foreign person (such as stock of a foreign subsidiary owned by a foreign parent) now is "attributed to" (deemed owned by) a lower-tier US person (such as a US subsidiary of the foreign parent) for purposes of determining whether a foreign corporation is treated as a CFC. Thus, if a foreign parent with one or more foreign subsidiaries also owns at least 50% of one US corporation, all foreign subsidiaries of the foreign parent that are more than 50% owned by such foreign parent (and that are treated as corporations for US federal income tax purposes) generally will be CFCs under the new rules because the US subsidiary will be deemed to own the foreign subsidiaries (satisfying the CFC requirement that US Shareholders own more than 50% of the stock of the foreign corporation).

In the below example of the application of the "downward attribution" rule (Example 1), before the change to the downward attribution rule, the Foreign Subs would not have been CFCs because the US Persons who were US Shareholders directly or indirectly owned only 20% of Foreign Subs. As a result of the new tax rules, however, all of the Foreign Subs in Example 1 are now CFCs because the US Sub is deemed to own 100% of each of the Foreign Subs.

    
Additionally, if a co-investor in Foreign Parent is a foreign person with a US affiliate, the change in the "downward attribution" rule can result in the entire group of foreign companies becoming CFCs even if there is no US subsidiary in the group. In the below example of the application of the "downward attribution" rule (Example 2), before the change to the "downward attribution" rule, Foreign Parent and Foreign Subs would not have been CFCs. As a result of the new tax rules, however, Foreign Parent and Foreign Subs are now CFCs because the US subsidiary of Foreign Person is now deemed to own 80% of Foreign Parent, thereby increasing the amount of Foreign Parent and (indirectly) Foreign Subs treated as owned by US Shareholders to more than the threshold 50% required under the CFC rules.

10% Vote or Value

Under prior law, a "US Shareholder" was defined as a US person who owned, directly or indirectly, 10% or more of the total combined voting power of the stock of a CFC. Because the definition of US Shareholder only looked to voting stock, CFC and US Shareholder status could be avoided in some instances by limiting the amount of voting stock any US investor could own to 9.9% while preserving targeted economics by having the US investor acquire non-voting stock. Under the new law, a US Shareholder is now defined as a US person that owns 10% or more of the vote or value of the stock of a CFC. As a result of the change in law, a US person who owned, directly or indirectly, less than 10% of the vote but at least 10% of the value of the stock of a foreign corporation is now a US Shareholder under the CFC rules.

Consequences of being a US Shareholder of a CFC

Who is a "US Shareholder?"

These changes to the CFC rules, which have turned many foreign corporations that were not previously CFCs into CFCs, have prompted US persons who directly or indirectly own interests in these foreign corporations to question whether they are "US Shareholders" of a CFC subject to potential annual income inclusions discussed further below. As discussed above, a US Shareholder is a US person who directly or indirectly owns at least 10% of the vote or value of a foreign corporation. In a simple structure where a foreign corporation is directly owned by individuals, it generally is easy to determine whether someone is a US Shareholder. Many foreign corporations are owned, however, by funds or other investment vehicles where it is difficult to determine the level of ownership by specific individuals. In addition, the CFC rules have many "attribution" rules that operate to aggregate the ownership of related persons. Although these rules are complex, here are few simple guidelines to determine "ownership" under the CFC rules:

• To determine whether an individual is a US Shareholder of a particular foreign corporation, start with that foreign corporation, look at its direct shareholders and, for any direct shareholder that is not an individual, keep looking through such shareholder entity (and its shareholders) until you determine the individuals who indirectly own the foreign corporation. Any US individual who directly or indirectly owns at least 10% of the foreign corporation (aggregating such US individual's ownership through all chains) is a US Shareholder.
• If you find a US entity (other than an LLC or partnership that is a disregarded entity for US tax purposes) in the ownership chain that directly or indirectly owns at least 10% of the vote or value of the foreign corporation, that US entity is a US Shareholder. If the entity is a US corporation, that US corporation will be subject to the CFC rules applicable to US Shareholders. If the entity is an LLC or partnership (that is not disregarded) any US person who is a member or partner, regardless of whether such US member or partner indirectly owns 10% of the foreign corporation, will be subject to the CFC rules applicable to US Shareholders.
• Entities managed by the same manager generally are not treated as "related" except to the extent they have common ownership. Thus, common "cross" ownership of entities must be determined and a US person's ownership through multiple entities must be aggregated. Funds often consider the list of their owners to be confidential—but if it is necessary to determine cross-ownership among funds, an accountant or lawyer can review potential cross ownership on a confidential basis.
• The "downward attribution" rules described above result in certain US entities being treated as US Shareholders for purposes of determining whether a foreign corporation is a CFC. If these US entities are US Shareholders solely due to the "downward attribution" rules, however, these US entities are not subject to the CFC rules applicable to US Shareholders.

Consequences Under Existing Law

Under existing provisions of the CFC rules, any US Shareholder who owns a CFC at the end of the tax year generally must include in its income its pro rata share of (i) certain passive types of income (such as interest, dividends, gains, rents and royalties) of the CFC regardless of whether the income is distributed as a dividend by the CFC and (ii) the CFC's investments in "US property.""US property" includes a loan made to a US person if such loan is owned by or guaranteed by the CFC (or if the CFC pledged its assets or had more than 65% of its voting stock pledged to secure the loan). For example, if a foreign corporation provided a guarantee or pledged its assets or had more than 65% of its voting stock pledged for a loan to a US person (perhaps because under prior law, such foreign corporation was not a CFC) and, due to the change in tax rules (in particular the "downward attribution" rule), the foreign corporation is now a CFC, a US Shareholder of such CFC might have an income inclusion of the full principal amount of the loan beginning as soon as the 2017 tax year (see discussion below regarding the effective dates for the TCJA). There is no "grandfather" provision to this rule—loans and guarantees/pledges already in place in 2017 are subject to this new rule.

New "GILTI" Provision

The TCJA added a new inclusion rule for certain CFC income, titled "global intangible low-taxed income" ("GILTI"). The new rule, which is designed to subject greater amounts of CFC income to a minimum tax, requires each US Shareholder of a CFC to include annually in its income its pro rata share of the CFC's GILTI.

In general, GILTI equals the CFC's aggregate net income, reduced by 10% of the CFC's adjusted tax basis in depreciable tangible personal property. The required income inclusion is determined by a complicated formula, and the resulting inclusions could be substantial. While the new GILTI rule affects both corporate and non-corporate US Shareholders, it likely will result in significantly higher costs to non-corporate US Shareholders, such as individuals and trusts.

Under the new GILTI rule, corporate US Shareholders are entitled to certain GILTI relief provisions which may reduce the potential impact of the new inclusion requirements. For example, corporate US Shareholders are entitled to reduce their GILTI by 50%. The US federal corporate tax rate under the TCJA is 21%. Consequently, corporate US Shareholders are subject to an effective US corporate minimum tax of 10.5% on GILTI. Furthermore, corporate US Shareholders are entitled to claim a credit for foreign taxes paid or accrued by the CFC on the GILTI, which may reduce or eliminate additional US federal income tax obligations (to the extent foreign tax credits are available).

In contrast, non-corporate US Shareholders are not eligible for comparable relief. They are not able to deduct 50% of their GILTI, and generally cannot claim a credit for foreign taxes paid or accrued by the CFC on the GILTI. Additionally, they are subject to a US federal income tax rate of up to 37%.

Effective Dates for New Provisions

The "downward attribution" rule is effective for the last taxable year of the foreign corporation beginning prior to January 1, 2018. Thus, a foreign corporation that is a calendar year taxpayer could have become a CFC beginning with the 2017 tax year, and there is no grandfathering provision. The changes to (i) add "value" to the US Shareholder definition (thus now "vote or value") and (ii) the addition of the GILTI provision are effective for a corporation's tax years beginning after December 31, 2017 and for a shareholder's tax year that includes such corporation's tax years ending after December 31, 2017. Thus, all of these new CFC provisions are currently effective and could already have had significant impacts on US Shareholders for the 2017 tax year.

Possible Mitigation of Effects of New Tax Law

The consequences of the TCJA on minority US Shareholders of entities that are now CFCs can be significant and, based on the legislative history, may not have been intended. There is an effort by interested parties to either have the Treasury issue official guidance or have Congress act to mitigate the impact of these new rules. It is not clear, however, whether there will be any actions taken to mitigate the impact of these new rules. Thus, as of now, these new rules are effective and taxpayers are required to follow them.

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Recent remarks by the new Chairman of the Board of Governors of the Federal Reserve System ("FRB") and Comptroller at the Office of the Comptroller of the Currency ("OCC") signal that the federal banking agencies ("Agencies") may be backing away from the relatively prescriptive approach to assessing the leveraged lending activities of regulated banks set forth in the Agencies' 2013 Leveraged Lending Guidance ("LLG") in favor of a more risk-based safety and soundness approach.¹

Background

The status of the LLG has been in limbo since the General Accountability Office ("GAO") determined in October 2017 that the LLG is a "rule" under the Congressional Review Act ("CRA").² The CRA requires federal agencies to submit new rulemakings to Congress and gives Congress the right to review a rulemaking and, by joint resolution, disapprove a rule prior to its effectiveness.³ The GAO finding left the Agencies with the choice of submitting the LLG to Congress, issuing similar new guidance as a rule that would be submitted to Congress for CRA review, or abandoning the LLG altogether in favor of an alternative approach. Recent remarks by the new Chairman of the FRB and the OCC Comptroller indicate that the Agencies are considering the latter approach.

For a discussion of the GAO determination, please see our Alert available here.

Recent Remarks of the Agencies

On February 27, 2018, FRB Chairman Jerome Powell and OCC Comptroller Joseph Otting each made separate public remarks regarding the status and future prospects of the LLG.

In his testimony before the House Financial Services Committee ("HFSC") on February 27, FRB Chairman Powell stated that, "in the case of the leveraged lending guidance we do accept and understand that that’s non-binding guidance."⁴

The Chairman's statement came in response to a question from the Chairman of the House Financial Institutions and Consumer Credit Subcommittee, Blaine Luetkemeyer, who asked: "[W]ould you agree that rules are rules and guidance is guidance and guidance is not binding."⁵ Chairman Luetkemeyer indicated that his question was based on reports from banks that examiners are continuing to treat the existing guidance as binding in respect of outstanding matters requiring attention ("MRAs") despite no one disputing the GAO finding that the LLG is a rule that requires submission to Congress before being treated as effective. The FRB Chairman noted that the FRB has "made it a point to go out and make sure that that message [of the LLG's non-binding status] is getting out to supervisors of banks." He referenced the "good intentions" of new leadership of the agency, including the FRB’s new vice chairman in charge of bank supervision, Randal Quarles, to communicate to the entire agency that "an understanding needs to take place by everybody that this is a new way of doing business—that guidance is guidance, rules are rules, and there's a big difference between how they’re adjudicated and administered and enforced."⁶

On the same day, OCC Comptroller Joseph Otting told attendees at a Structured Finance Industry Group conference that "[i]nstitutions should have the right to do the leveraged lending they want, as long as they have the capital and personnel to manage that and it doesn't impact their safety and soundness."⁷ He went on to specify that safety and soundness concerns would be raised by "a ton" of leveraged lending, highly concentrated lending or deterioration in a leveraged lending portfolio. In an interview later that day, he clarified that "[w]hat we are telling banks is you have capital and expected loss models and so if you are reserving sufficient capital against expected losses, then you should be able to make that decision."⁸ The Comptroller voiced support for banks having the right to "do what you want as long as it does not impair safety and soundness."⁹ He noted that the LLG has created an atmosphere where jumping over the "line" set by the LLG would result in "feeling the wrath of Khan from the regulators" and specified that his approach would permit banks to transgress guidelines so long as they have sufficient capital.¹⁰

Potential Actions by the Regulatory Agencies

As noted by FRB Chairman Powell in his HFSC testimony, the FRB is advising its examiners not to treat the LLG as a rule. His point that there is a "big difference" between how rules and guidance are adjudicated, administered and enforced would seem to indicate that, to the extent the Agencies intend to retain the LLG as "non-binding" guidance, its prescriptive limits—such as borrower leverage in excess of six times total debt-to-EBITDA – should not be used as the basis for MRAs or other adverse supervisory action by examiners.

The FRB Chairman also noted that the Agencies are considering alternatives to the LLG that include putting out new guidance for comment. The OCC Comptroller’s comments, on the other hand, suggest the Agencies may not pursue issuance of new guidance or a proposed rulemaking and seek, instead, to monitor the leveraged lending activities of banks under the Agencies’ statutory "safety and soundness" authority. That authority permits the Agencies to take action against a bank deemed to be engaged in unsafe or unsound activities. In general terms, that requires a finding that a bank lacks adequate internal controls and other operational and managerial standards and/or adequate capital to ensure that its leveraged lending activities are conducted in a manner that does not jeopardize the bank’s safety and soundness or, alternatively, that the quantity or quality of leveraged loans held poses such a risk. Such determinations are generally based on an assessment of the risks of an activity or asset to the particular bank being examined, rather than attributing the risks of the bank’s loans based on the size, purpose or borrower's leverage ratio of the loans held. Generally, this approach would provide more flexibility, require greater examiner judgement and, in this regard, provide less certainty and, presumably, less uniformity than a bright-line benchmark such as a 6.0 times leverage limit of the LLG. Therein lays the tradeoff.

Earlier leveraged lending guidance replaced by the LLG adopted the approach articulated by the Comptroller, establishing an expectation of reasonable amortization of loans, but not specific quantified limits for determining reasonableness. If the Agencies decide to limit new guidance to these types of "reasonable" standards, reviews by Agency examiners could become more subjective, with assessments of the proper classification of syndicated loans determined based on the adequacy of a bank’s operational and managerial standards and capital position, rather than the borrower's leverage and financial projections. Again, this tradeoff, sacrificing certainty and predictability in favor of judgement and flexibility, was largely the catalyst for the bright line standard articulated in the LLG by the Agencies in 2013—which is now the subject of significant criticism.

Agencies Tailor Loans Subject to SNC Program

If there is any doubt that the Agencies are serious about addressing the concerns and criticism regarding the constrictiveness of the LLG, we need to look no further than recent actions to modify the Shared National Credit Program ("SNC Program"). In December, the Agencies raised the threshold for syndicated loans subject to reporting and review under the SNC Program, signaling what appears to be a clear change in approach to monitoring bank-leveraged lending activities. In this regard, the Agencies raised the threshold for the aggregate commitment amount of loans covered by the SNC Program to $100 million from the $20 million threshold that had been in place since the SNC Program was established in 1977.¹¹

Potential Implications for Banks

The recent remarks by the new heads of the FRB and OCC indicate that, going forward, the LLG’s prescriptive limits should not be used by examiners as the basis for MRAs requiring banks to classify participations in syndicated loans as special mention, sub-standard or doubtful and, as appropriate, banks can adjust their regulatory capital treatment accordingly. While outstanding MRAs should not be ignored, the remarks pave the way for a dialogue with examiners on the resolution of such issues.

The remarks suggest that, from the Agencies' perspective, the LLG prescriptive limits are "non-binding" and, perhaps, no longer being applied at all. In this regard, however, the remarks do not offer a clear indication of how the Agencies will look to assess bank-leveraged lending activities going forward. Thus, banks should be prepared to continue to defend their leveraged lending activities, understanding that the bright lines of the LLG are now being supplanted by examiner judgment and discretion regarding safety and soundness in the context of a bank’s leveraged lending program and activities. The remarks create an expectation that examinations may focus less on the amount of leverage and other quantifiable criteria of borrowers and more on the reasonableness of the amortization and other terms of a leveraged loan, the adequacy of a bank's management procedures and internal controls to assess the potential safety and soundness risks presented by such lending activities, and the adequacy of regulatory capital levels to withstand classification or default of leveraged loan assets.

Global banks subject to supervision by the European Central Bank ("ECB") should also be aware that a move away from the existing LLG approach by the Agencies may not relieve banks of the need to maintain adequate policies and procedures and systems to monitor their leveraged lending based on LLG-type criteria applied by the ECB. Existing ECB guidance for how EU banks should treat leveraged loans is modeled, in part, after the LLG prescriptive limits, including the use of borrower leverage ratio limits to determine whether a loan is a leveraged transaction.¹²

Issues for Further Consideration

At this juncture, banks subject to the LLG and actively engaged in leveraged lending activities should seek to obtain as much clarity as possible from their regulators regarding examination and review of their leveraged lending activities and program. In particular, banks should inquire regarding examiners' expectations of what they view as a reasonable level of amortization, the reasonableness of other terms of a leveraged loan, the adequacy of a bank's internal controls and management procedures to assess safety and soundness risks with leveraged lending activities, and the adequacy of regulatory capital levels to withstand classification or default of leveraged loan assets.

It remains unclear exactly how and to what degree we will see palpable, rather than incremental, movement in the supervisory and examination response to leveraged lending going forward. The extent to which, how, and how quickly, reforms will be carried out are issues of keen interest to regulated institutions in the leveraged lending space. It often takes considerable time and effort not only to implement the type of programmatic supervisory reforms suggested by FRB Chairman Powell and Comptroller Otting, but also for regulated institutions to understand, adopt and adjust to the new approach(es) embraced by the regulators.

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¹ Interagency Guidance on Leveraged Lending (March 21, 2013), available at https://www.federalreserve.gov/supervisionreg/srletters/sr1303a1.pdf.
² GAO Letter to Sen. Pat Toomey, 163 Cong. Rec. S6636 (Oct. 19, 2017).
³ 5 U.S.C. § 801(a)(1)(A).
⁴"Monetary Policy and the State of the Economy," hearing before the US House Financial Services Committee, remarks of FRB Chairman Jerome Powell (Feb. 27, 2018).
⁵Id.
⁶ Id.
⁷ "OCC Head Says Banks Not Bound by Lending Guidelines, Expects Leverage to Increase," Debtwire (Feb. 27, 2018), available at https://www.debtwire.com/info/occ-head-says-banks-not-bound-lending-guidelines-expects-leverage-increase
⁸ Id.
⁹"Banks Can 'Do What They Want' in Leveraged Lending: Otting," Reuters (Feb. 27, 2018), available at https://www.reuters.com/article/us-usa-banks-lending-otting/banks-can-do-what-they-want-in-leveraged-lending-otting-idUSKCN1GC0B5.
¹⁰ Id.
¹¹ Agencies Joint Press Release, "Agencies Announce Shared National Credit Definition Change; Aggregate Loan Commitment Threshold Increased to Adjust for Inflation, and Changes in Average Loan Size" (Dec. 21, 2017), available at https://www.federalreserve.gov/newsevents/pressreleases/bcreg20171221c.htm.
¹² "ECB Publishes Guidance to Banks on Leveraged Transactions" (May 16, 2017). We addressed the ECB Guidance in our client alert available here.

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© 2018 White & Case LLP

Welcome to the most recent issue of our Russian Legislation Update, covering the period of January – February 2018.

In this issue:

• Banking
• Currency Control
• Anti-Money Laundering
• Disclosure of Information
• Special Investment Contracts
• Procurement

Banking

On 6 December 2017 the Central Bank issued Directive No. 4635-U amending Instruction No. 180-I "On Mandatory Economic Ratios."

The Directive was registered with the Ministry of Justice on 10 January 2018.

According to the Directive, the Instruction sets out economic ratios only for banks with a "universal" license.

For the purpose of implementing the Basel III standards, a new mandatory ratio is established for banks with a "universal" license: a non-risk-based capital adequacy ratio (leverage ratio, N1.4).

The leverage ratio is the ratio of the bank's core capital to its balance sheet exposures; contingent credit liability exposures; derivative exposures and securities financing transaction exposures.

The minimum requirement for the leverage ratio is set at 3%.

The Directive entered into force on 27 January 2018.

On 6 December 2017 the Central Bank issued Directive No. 4637-U amending Directive No. 4212-U on banks' reporting forms.

The Directive was registered with the Ministry of Justice on 25 December 2017.

The Directive introduces new reporting forms (including the calculation of the net stable funding ratio by systemically important banks, report on changes in a bank's capital (in a published form)) and amends the procedure for preparing and/or submitting a number of reporting forms (including forms for the loans granted to legal entities and for mandatory economic ratios).

The amendments entered into force on 31 December 2017, save for certain provisions that will enter into force later.

Currency Control

On 28 December 2018 the President signed Federal Law No. 427-FZ amending the Currency Control Law.

The amendments relate to resident individuals. Now, all Russian citizens are considered as residents. However, Russian citizens who spend more than 183 days per year in another country are no longer subject to the Law on opening overseas accounts, carrying out transactions through such accounts and reporting on such accounts. Moreover, those individuals are allowed to make currency operations between themselves while they are abroad.

Further, resident individuals, who transfer funds to their overseas bank accounts for the first time, are no longer required to present a bank with the tax authorities’ notification of opening such accounts. In addition, funds held in such accounts can now be used without limitations, save for prohibited currency operations between residents (previously the restriction applied to currency operations related to the transfer of assets or rendering services in Russia).

The amendments also expand a list of the allowed crediting operations with respect to overseas bank accounts of resident individuals. Accounts opened with banks in the OECD or the FATF-member states can now be credited with: 1) proceeds from the sale of a vehicle located abroad to a non-resident; and 2) proceeds from the sale of the immovable property located abroad to a non-resident (provided the property is located in the OECD or the FATF-member state, this state is a party to an agreement on automatic exchange of financial information with Russia and the account is opened at a bank located in such state).

The Law entered into force on 1 January 2018.

On 30 August 2017 the Central Bank issued Directive No. 4512-U "On the Scope and Procedures for Providing Information by Banks Authorized to Act as Currency Control Agents to Currency Control Authorities."

The Directive was registered with the Ministry of Justice on 8 December 2017.

Pursuant to the Directive, banks are required to inform currency control authorities in an electronic form about the registered contracts, changes in the data on such contracts and removal of the registration of contracts. Information about foreign trade contracts must be provided to the Federal Tax Service of Russia and the Federal Customs Service of Russia; the Federal Tax Service of Russia must be also provided with information about loan agreements. Information is provided through the Central Bank. It includes information about contracts/agreements as well as copies of contracts/agreements.

The relevant rules for preparing and submitting information in an electronic form are available on the Central Bank's website www.cbr.ru.

The Directive (as amended by Directive No. 4659-U of 21 December 2017) entered into force on 1 March 2018 and abolished Regulations Nos. 364-P и 402-P on similar matters.

On 16 August 2017 the Central Bank issued Directive No. 4498-U regarding the procedures for banks for providing information about violations of currency regulations to currency control authorities.

The Directive was registered with the Ministry of Justice on 18 January 2018.

Pursuant to the Directive, banks must provide the Central Bank with information in an electronic form about detected violations of currency regulations which subsequently will be provided to currency control authorities. The reporting period will amount to 10 days (previously it was one month).

The relevant rules for preparing and submitting information in an electronic form are available on the Central Bank's website www.cbr.ru.

The Directive entered into force on 1 March 2018 and abolished Regulation No. 308-P on similar matters.

Anti-Money Laundering

On 29 December 2017 the President signed Federal Law No. 470-FZ amending the Anti-Money Laundering Law and a number of other laws.

The amendments aim to create a mechanism for the rehabilitation of clients if a financial organization refused to carry out a transaction or open a bank account for them.

Taking into account the grounds for the decision of a financial organization, the client will be able to provide it with information or documents showing the lack of grounds for such a decision. In case of a negative response, the client will be able to apply to an interdepartmental commission within the Central Bank.

If the grounds for the decision are eliminated or an interdepartmental commission concludes that there are no grounds for the decision, a financial organization is obliged to inform Rosfinmonitoring (an anti-money laundering authority) accordingly.

The described amendments will enter into force on 30 March 2018.

On 31 December 2017 the President signed Federal law No. 482-FZ amending the Anti-Money Laundering Law and a number of other laws.

Following the identification of an individual client while he/she is present and subject to his/her consent, banks are obliged to enter and update information about that individual in: 1) a unified identification and authentication system; and 2) a unified biometrical system. Based on the information entered in those systems, banks will be able to identify those individuals remotely and then open and maintain their bank accounts (deposits), provide loans to them and make transfers through their bank accounts without their personal attendance.

The above opportunities are available only to banks that meet certain criteria (e.g. banks that participate in a deposit insurance system). A list of eligible banks will be published on the Central Bank's website (www.cbr.ru) on a monthly basis.

Moreover, it will be possible to conduct transactions after a remote identification is done only if certain conditions are met (e.g. if a bank does not suspect that a transaction is carried out for money laundering purposes).

The Central Bank can provide restrictions on the total number of bank accounts (deposits), total value of loans and transfers following the remote identification. In case a limit to the number of bank accounts is set, a bank will need to inform the Central Bank about all the accounts opened following such identification.

Moreover, information about individuals contained in the unified identification and authentication system will be provided to Rosfinmonitoring (an anti-money laundering authority) and the Central Bank.

Apart from the matters relating to the remote identification, the amendments also relate to the disclosure issues. The Government was vested with the authority to restrict the disclosure of information by credit and other financial organizations.

The amendments regarding the disclosure of information entered into force on 31 December 2017, other amendments will enter into force on 30 June 2018.

Disclosure of Information

On 31 December 2017 the President signed Federal Law No. 481-FZ amending the Basic Principles of Notary Activities, the JSC and LLC Laws, Law on the State Registration of Legal Entities and a number of other laws.

The Law vests the Government with the authority to restrict the disclosure of information. The Government is authorized to set restrictions when:

• information about a pledgeholder recorded in the register of notices of pledges of movable property will not be published on the Internet;
• information (as provided for in the Law) recorded in the Unified Federal Register of Data on Certain Facts of Activities of Legal Entities will not be published on the Internet;
• information about major transactions and interested party transactions will not be disclosed.

The Government is also authorized to restrict the disclosure of information by the securities' issuers, the submission of information to credit history bureaus, the provision of information to auditors, publishing information about suppliers based on Federal Law No. 223-FZ and the disclosure of consolidated financial statements.

The Law entered into force on 31 December 2017.

On 25 January 2018 the Government adopted Resolution No. 65 "On Restrictions on Publishing Information about Pledgeholders of Movable Property on the Internet."

Pursuant to the Resolution, a notice of pledge can contain a refusal to publish information about a pledgeholder on the Internet (www.reestr-zalogov.ru), if the disclosure of such information leads or may lead to imposition of international/foreign sanctions on the pledgeholder.

The Resolution entered into force on 6 February 2018.

On 12 January 2018 the Government adopted Resolution No. 5 specifying cases in which certain information recorded in the Unified Federal Register of Data on Certain Facts of Activities of Legal Entities will not be published on the Internet.

Pursuant to the Resolution, if a company or an entrepreneur is subject to international/foreign sanctions, certain information "with respect to such persons" recorded in the Unified Federal Register of Data on Certain Facts of Activities of Legal Entities should not be published on the Internet (www.fedresurs.ru). Restrictions apply to the following information:

• pledge of movable property (other than information on a company-pledgor, which must be available on the Internet);
• issuance of an independent guarantee;
• entering into a factoring agreement by a client;
• financial (accounting) statements if they are subject to disclosure in mass media;
• information which must be recorded in the specified register pursuant to laws other than the Law on the State Registration of Legal Entities (on entering into a leasing agreement by a lessor; on levying execution on certain assets of a debtor in enforcement proceedings etc.).

The Resolution entered into force on 25 January 2018.

On 15 January 2018 the Government adopted Resolution No. 10 specifying cases in which joint stock companies and limited liability companies are not obliged to disclose and (or) provide information relating to major transactions and interested party transactions.

Pursuant to the Resolution, when entering into a major transaction or an interested party transaction with a Russian company or an individual which/who is subject to international/foreign sanctions, JSCs and LLCs are entitled not to disclose/not to provide information relating to such deal or "with respect" to such counterparties.

The Resolution entered into force on 25 January 2018.

On 21 December 2017 the Government adopted Resolution No. 1604 regarding submission of information relating to the manufacturing and industry sector.

Entities engaged in the production sector are required to regularly provide certain data regarding the manufactured products to the Ministry of Industry and Trade (the scope of information and the frequency of its submission are specified in the Resolution). Some information must be also provided by the state and municipal authorities (e.g. policies for supporting industrial development). Information will be used for maintaining the state information system for the manufacturing and industry sector.

The Resolution will enter into force on 23 June 2018.

Special Investment Contracts

On 16 December 2017 the Government adopted Resolution No. 1564 amending Resolution No. 708 on special investment contracts.

The amendments aim to improve regulation of special investment contracts. In particular, the amendments: (i) set out criteria to be met by an investor (e.g. it should not be an offshore company/ controlled by an offshore company); (ii) specify requirements for the documents provided by the investor (a set of documents must include, among other things, a project timeline and an investment timeline (by year) and a flowchart showing participants in the project; a business plan and a financial model must meet the specified requirements); (iii) set out additional criteria for making a decision on whether it is possible (impossible) to execute a contract; (iv) detail the procedures for amending and terminating a contract; and (v) change a template of the contract.

The described amendments will enter into force on 16 June 2018.

Procurement

On 31 December 2017 the President signed Federal Law No. 505-FZ amending Law on Procurement of Goods, Works and Services by Certain Types of Legal Entities No. 223-FZ.

As of 31 December 2017, the amendments: (i) expand a list of cases to which Law No. 223-FZ does not apply by adding, among other things, the procurement from interdependent persons; (ii) envisage a possibility of having single procurement policies applying to holding companies (subsidiaries are allowed to apply a procurement policy of a parent company); (iii) expand the scope of data which does not need to be published in a unified procurement system – e.g. the data on procurement of services with respect to placing deposits, receipt of loans, issuance of bank guarantees and suretyships, opening letters of credit; and (iv) set out the requirements for interaction between the corporate information system and the unified procurement system.

In addition, as of 1 July 2018, the amendments provide a number of requirements applicable to the competitive procurement process (including non-public competitive procurement) and set out specifications of carrying out such procurement in an electronic form. With respect to a single-source procurement (i.e. non-competitive procurement) the amendments provide that: (i) the procedure for such procurement and an exhaustive list of circumstances under which it is carried out must be specified in a procurement regulation; and (ii) information about such procurement can be recorded in a unified procurement system if such publication is envisaged by the procurement regulation (i.e. the recording of such information is not required).

Internal procurement regulations must be brought in compliance with new requirements by 1 January 2019.

The amendments entered into force on 31 December 2017 (save for certain provisions which will enter in force on 1 July 2018, as noted above).

On 31 December 2017 the President signed Federal Law No. 496-FZ amending Law on Procurement of Goods, Works and Services by Certain Types of Legal Entities No. 223-FZ.

Law No. 223-FZ provides specifications of procuring certain mechanical engineering products by companies (including private entities) which implement investment projects with state support. The amendments will apply to investment projects worth more than RUB 500 million (the regulation currently applies to projects worth not less than RUB 10 billion). In addition, procurement specifications will also apply to the procurement of works, services and leases with respect to the specified products.

The amendments also provide specifications of procuring products to be identified by the Government and related works, services and leases by companies which are controlled by the state (without limiting these specifications to investment projects or mechanical engineering products).

The amendments will enter into force on 30 June 2018.

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© 2018 White & Case LLP

Jason is an associate in the Bank Finance Practice Group of White & Case's New York office. He has experience representing agents, lead arrangers, investors, private equity sponsors and other corporate borrowers in a wide range of credit facilities, including secured and unsecured syndicated financings, cross-border acquisition financings, ABL facilities, debtor-in-possession and exit financings, and general bank lending.

Prior to joining White & Case, Jason practiced corporate law, focusing on public and private mergers and acquisitions and securities law at a major Canadian law firm.

Axel Fägerhall is an associate in our Bank Finance practice in Stockholm and joined White & Case in 2018.

Axel is a dual-qualified lawyer (Australia and Sweden) and his experience includes acting for private lenders, property developers, national franchisors, small to medium sized enterprises and ASX and foreign-listed corporations.

Prior to joining White & Case, Axel worked at a commercial law firm in Melbourne, Australia, with a focus on Property Acquisitions and Property Finance.

Global law firm White & Case LLP has advised Enel Américas S.A., a Chilean subsidiary of Enel S.p.A., on its up to US$1 billion revolving financing.

The facility has been granted by a group of lenders led by BNP Paribas as documentation agent, and Credit Agricole as administrative agent, and also including Citibank, JPMorgan and Sumitomo Mitsui.

The White & Case team which advised on the transaction comprised partners Iacopo Canino, Ferigo Foscari (both Milan) and Sabrena Silver (New York), and associates Adriana Tisi (Milan) and Celeste Jackson (New York).

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