Wednesday, 1 March 2017


Following Sullivan & Worcester’s Breakfast Seminar in London last December, Geoff Wynne has highlighted below a few matters that are worth bringing to everyone’s attention. We trust that these short summaries will be helpful to you when considering whether you need to take any further action or not in the normal course of your business. A copy of the full deck and replay of the seminar can both be found on the S&W website.

FACTA - Where do we stand and what to do

The Foreign Account Tax Compliance Act (FATCA) is a complex piece of US legislation, enacted in March 2010, the primary objective of which is to identify non-compliance by US taxpayers using offshore accounts. The remit of FATCA is far-reaching, and includes a requirement for foreign financial institutions (FFIs) (a broadly defined term which includes traditional banks as well as a broad array of non-bank financial institutions, including hedge funds) to annually disclose information about accounts held by US individuals or foreign companies in which US individuals hold a substantial ownership interest.

Although FATCA is technically a voluntary reporting regime, FFIs that refuse to comply by entering into an agreement with the Internal Revenue Service (IRS) to provide information will face a stringent penalty in the form of a withholding of 30% off all their US-source payments income (such as interest and dividends). Foreign banks are thus essentially forced to cooperate at the risk of losing access to US capital markets.  FATCA provisions are now in effect.

FATCA compliance poses several practical and legal issues. FFIs of various jurisdictions may face a conflict of laws and obligations – the disclosure requirements imposed by FATCA versus local data protection, confidentiality and bank secrecy laws. In order to alleviate this conflict, countries enter into bilateral agreements with the IRS in order to elevate FATCA compliance onto a national level. 

One of the legal effects of FATCA is that many lenders are including FATCA-specific wording in contracts to the effect that they are entitled to withhold tax as and when required by FATCA without the need for gross-up payments, even when such wording does not have contextual applicability. Any lender which is not FATCA compliant by the applicable time limit therefore risks receiving interest and principal net of FATCA withholding.

On a practical level, there are various drafting options for lenders which make FATCA a risk for the borrower, either: by (1) relevant obligors representing that they are outside the scope of FATCA; and/or (2) an actual gross-up and indemnity. Such options are particularly useful if the lenders in question are not certain that they will be FATCA compliant.

Sample drafting to give effect to the first option includes a representation from the obligor that ''it is not a FATCA FFI or a US Tax Obligor'' and a procurement from the [Company] that ''no Obligor will become a FATCA FFI or US Tax Obligor''. Additionally, a lender should consider including wording to the effect that ''…the [Company] shall procure that any Obligor which is a FATCA FFI or a US Tax Obligor shall resign as Borrower or Guarantor (as the case may be)…''.

Sample gross-up wording, whether made by an obligor or lender should refer to the fact that: ''the amount of payment due from the Obligor shall be increased to an amount which (after making any FATCA Deduction) leaves an amount equal to the payment which would have been due if no FATCA Deduction had been required''. The above wording examples are not necessarily enough when protecting a lender from the risk of FATCA non-compliance; they are merely intended as samples.

Article 55 BRRD – Where are we?

Article 55 of the Bank Recovery and Resolution Directive (the BRRD) imposes an obligation on institutions subject to it to include an ‘Article 55 clause’ (described below) in agreements entered into on or after 1 January 2016 and governed by the laws of non-EU countries (Third Country Agreements).

The Article 55 clause in such a case must include: (i) a recognition by the institution’s counterparty that amounts owed by the institution subject to BRRD may be written down or converted into equity as part of a bail-in; and (ii) an agreement by the counterparty to be bound by any such reduction or conversion.

The BRRD’s remit is broad and applies to EU credit institutions (banks and building societies, for example) and certain EU investment firms authorised under the Markets in Financial Instruments Directive (MiFID), the ‘Affected EU Institutions’.

The purpose of the above requirement is to address the question of the enforceability of bail-in powers by a resolution authority against counterparties in Third Party Agreements. Within the EEA, the effectiveness of statutory bail-in powers is ensured by the mutual recognition requirements under the BRRD. Beyond the borders of the EEA where mutual recognition does not apply, the BRRD purports to fill the gap by offering a contractual solution whereby the counterparty is held to the agreed contractual terms, thus preventing potential court challenges in the relevant non-EEA jurisdiction, the resolutions of which would involve examining the relevant governing law and applicable conflicts of law principles.

The nature of some transactions and documentations make compliance with bail-in requirements impractical - short-term trade finance and letters of credit being examples of this. Many take the view that an ‘impractical’ solution (whereby bail-in rules can be applied by resolution authorities in a proportionate manner, including, in some cases by granting a waiver all together) can be applied to all “standard” rules, including those promulgated by the ICC, for example in relation to letters of credit and demand guarantees.

More amendments are underway to the broadly drafted bail-in requirements; where this will leave the Affected EU Institutions will be a topic to follow. One point under consideration is the potential limitation of the BRRD to arrangements which affect bank capital and not its funding or general banking arrangements.

Dodd-Frank Act:

The Dodd-Frank Act (the Act), enacted in July 2010, drastically reformed financial regulation in the US in a bid to avoid another financial crisis, such as the one witnessed in 2008.  Currently, only around 70% of the 398 required rules are in place. 

Two areas of the Act have caused some concern for financial institutions within trade finance and in relation to participation agreements (MRPAs). The first relates to Title VII of the Act, and the second relates to the so-called ‘Volcker Rule’. In essence, both relate to involvement in derivatives and what it would mean if an MRPA were treated as a derivative. 

The Volcker Rule seeks to prohibit banks from the proprietary trading of their own accounts as well as from sponsoring or owning private equity or hedge funds, save for limited circumstances.  The general view is that including MRPAs between financial institutions cannot have been intended as these are regulated by banking authorities.

After much debate, the market has taken comfort in the fact that MRPAs are not derivatives and are therefore outside these provisions, save perhaps for the question of whether a risk participation in a funded transaction is still caught.  A clear statement from the regulator has been sought but not obtained.  Some law firms, including Sullivan & Worcester, have argued that there should be no problem, and that the “identified banking products” exemption should apply in this case as well as in others.  It is for participants to consider whether they can proceed on this basis. To date, there has been no challenge by the regulator to this view.

In line with his stance on the need to dispose of the Act, US President, Donald Trump, has recently signed an executive order which is to scale back the Act in a bid to dismantle much of the regulation that was implemented after the financial crisis of 2008.  The practicalities of scaling back the Act will no doubt involve a long and arduous process, but the question remains as to what regulation, if any, Donald Trump proposes to use in order to fill the US regulatory void.

Disclaimer: This information does not constitute legal advice and is for education purposes only.  You should not rely on this opinion as an alternative to seeking legal advice.

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