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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