bank collaboration with fintech companies: structuring...

Bank Collaboration With Fintech Companies:

Structuring Alternatives, Contract Provisions,

Regulatory Concerns

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THURSDAY, JULY 25, 2019

Presenting a live 90-minute webinar with interactive Q&A

Mark T. Dabertin, Special Counsel, Pepper Hamilton, Berwyn, Pa.

Samuel G. Kramer, Partner, Baker & McKenzie, Chicago

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STRAFFORD CLE

BANK COLLABORATION WITH FINTECH COMPANIES: STRUCTURING

ALTERNATIVES, CONTRACT PROVISIONS, REGULATORY CONCERNS

Sam KramerBaker McKenzie LLP

July 25, 2019

© 2019 Baker & McKenzie Compliance Consulting LLC

Bank Collaboration with Fintech Companies

6


EMERGENCE OF FINTECH


• Goldman Sachs estimates the worldwide

fintech pie to be worth $4.7 trillion.

• There are more than 12,000 fintech startups

worldwide.

• The global fintech market size in 2018

reached $111.8 billion. (KPMG)

• Half of banking customers globally are now

using fintech firms (Capgemini)

• By 2022, mobile transactions are projected to

grow by 121%, eventually composing 88% of

all banking transactions. (CACI)

7


THE FED ON OUTSOURCING RISK


Guidance on Managing Outsourcing Risk

Board of Governors of the Federal

Reserve System (December 5, 2013)

o compliance risk

o concentration risk

o reputational risk

o country risks

o operational risks

o legal risks

8


FDIC ON THIRD PARTY RISK


FDIC - Guidance for Managing Third Party Risk (June 6, 2008)

Risk Management Process:

o risk assessment dispute resolution

o due diligence ownership and license

o contract structuring indemnification

o cost/compensation limits on liability

o performance standards

o reports

o audit

o confidentiality/security

o customer complaints

o BCP

o default and termination

9


FDIC ON THIRD PARTY RISK


Remarks by Jelena McWilliams on Fintech and the New

Financial Landscape - November 13, 2018

• innovation in banking goes back to the introduction of double entry bookkeeping in 15th C Europe.

• "what is different today is the speed and tremendous impact of technological innovation in and on banking, and the potential for technology to disrupt not just an institution or two, but banking as we know it. This is why it is crucial that policymakers and regulators understand the impact, scope, and consequences that are innate to what we have come to refer to as "fintechs".

• technology is transforming the business of banking - not only in how consumers interact with FIs, but also in the way banks do business.

• "while new technology can certainly introduce risk, it can also help regulators and institutions identify and mitigate risk sooner. And it will undoubtedly present opportunities to ease the burden of regulatory compliance."

10


OCC ON THIRD PARTY RELATIONSHIPS


OCC Bulletin 2013-29 – Risk Management

Guidance (October 30, 2013)

• risk management commensurate with level

of risk and complexity

• diligence of 3rd party

• contracts with clear obligations

• on-going monitoring and reporting

• independent reviews

11


OCC ON THIRD PARTY RELATIONSHIPS


OCC Bulletin 2017-21 – Frequently Asked

Questions to Supplement OCC Bulletin 2013-

29 (June 7, 2017)

• 3rd party relationships include affiliates and

subsidiaries and fintech companies

• in-depth diligence and ongoing monitoring

• not a one-time assessment

• collaboration permissible but may not be

appropriate

• financial diligence and fintech startups

12


OCC – RESPONSIBLE INNOVATION FRAMEWORK


Recommendations and Decisions for

Implementing a Responsible Innovation

Framework (October 2016)

• responsible innovation

• internal culture

• agency experience and expertise

• fair access to financial services and

treatment of consumers

• safe and sound operations through risk

management

• strategic planning

• ongoing dialogue through formal outreach

• collaborate with other regulators

13

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QUESTIONS?

Sam Kramer

[email protected]

mailto:[email protected]

Mark T. Dabertin

Extensive experience in banking, lending, safety and soundness, and anti-money laundering spanning nearly three decades

Regularly handles the drafting and negotiation of complex agreements between non-bank fintech companies and regulated banks

Routinely advises on merchant cash advance (MCA) matters

Prolific author on topics of interest to the financial services industry and frequently speaker at industry conferences

Special Counsel, Financial ServicesPepper Hamilton LLP610.640.7841

[email protected]

15

Bank ‒ Fintech Lending Relationships

“Banks should perform a thorough pre-analysis and risk

assessment on each marketplace lending company with which it

transacts business, whether acting as an institutional investor or

as a strategic partner.”

FDIC 2015 Winter Supervisory Highlights, Marketplace Lending.

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Bank‒Fintech Lending Relationships

There are various ways that a bank may partner with a fintech

lender:

A fintech lender may either license or provide user-access to

its credit underwriting platform in a relationship in which the

bank is the lender;

Ae bank or its parent holding company may provide funding to

a fintech lender in the form of equity capital, investments, or

warehouse credit; or

A fintech and bank may enter into a relationship whereby the

bank is the lender and the fintech either purchases whole

loans or acquires substantial participation interests in loans

made under the program, and also services program loans.

17


Payday lending can provide short-term access to credit, but it

often comes with high rates of interest and expensive fees.

A handful of national banks essentially rented out their charters

to third party payday lenders. The OCC found a number of

abuses in these relationships. Of primary concern was the

inability of small banks to properly oversee the third parties who

were making loans in their names. Among the abuses: deceptive

marketing practices, failure to secure confidential customer files,

and unsafe and unsound lending. The OCC took a series of

enforcement actions that eliminated these relationships from the

national banking system.

OCC Comment on Past National Bank Relationships With

Payday Lenders:

18


The FDIC Is More Welcoming to Lending Relationships:

The FDIC published draft Third-Party Lending Guidance for

comment on July 29, 2016, which remains in pending status

three years later.

The draft guidance acknowledges the most common types of

relationships, including those in which the bank may be

“originating loans for third parties in volumes that exceed the

size of the institution’s balance sheet by many multiples or

relationships with large, or multiple, widely dispersed third

parties.”

The draft guidance emphasizes that such relationships in no

way diminish the bank’s legal or oversight responsibilities.

19


Lending Relationships Between Banks and Fintechs May Become Subject to “True Lender” Legal Challenges

1. Facial Test: Cases where the court accepts without further proof that the party named as the lender is, indeed, the lender as a matter of law; and

2. Fact Test: Cases where the court attempts to look past the documentation to the “substance” of the transaction and identify the actual lender as between the bank and a related non-bank stakeholder by analyzing the facts to determine which of those parties has the predominate economic interest in the loan.

Courts tend to view true lender cases in one of two ways:

20


To determine if a contract is usurious, we critically examine the

substance of the transaction, regardless of the name given it, or

stated another way, ‘[t]he theory that a contract will be usurious

or not, according to the kind of paper-bag it is put up in, or

according to the more or less ingenious phrases made use of in

negotiating it, is altogether erroneous. The law intends that a

search for usury will penetrate to the substance.’

BankWest, Inc. v. Oxedine, 598 S.E.2d 343, 348 (Ga.App.

2004)

21


• In 2015, the Second Circuit Court of Appeals issued an opinion in

Madden v. Midland Funding, 786 F.3d 246, cert. denied, 2016 U.S.

LEXIS 4211 (U.S. June 27, 2016). in which the court refused to

recognize the “valid when made” doctrine.

• Madden has affected the structure of bank-fintech lending

relationships by encouraging banks to favor a structure in which

the bank holds the loan account and sells participation interests to

the fintech lender, which also services loans made under the

program.

22


• In 2017, the Administrator of the Colorado Uniform Consumer

Credit Code filed separate lawsuits against online lenders Avant

and Marlette Funding asserting that those non-bank financial

institution are the “true lender” in loans ostensibly made by banks

to residents of Colorado. The complaints are founded on both “true

lender” and Madden legal arguments.

• In November 2018, the Administrator raised the stakes by adding

as defendants securitization trusts that have taken assignments of

payments under the loans made under the respective loan

programs.

23


“Having any affiliation or other business arrangement with an entity that is exempt from the provisions of this chapter pursuant to subsection 1 of NRS 675.040, the effect of which is to evade the provisions of this chapter, including, without limitation, making a loan while purporting to be the agent of such an exempt entity where the purported agent holds, acquires or maintains a material economic interest in the revenues generated by the loan.”

(Excerpt from the anti-evasion provisions of Nevada’s installment loan licensing statute. NRS 675.035.)

Navigating state licensing requirements under a lending

relationship can be challenging for the non-bank—

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https://www.leg.state.nv.us/NRS/NRS-675.html#NRS675Sec040

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