Monthly LRA Update: November 2020

REGULATORY DEVELOPMENTS

Banking Regulators Release Final Rule for TLAC Holdings of Advanced Approaches Banks

On October 28, the FDIC, FRB and OCC issued a joint final rule for TLAC holdings of advanced approaches banks. It amends the capital rules to require advanced approaches banking organizations to deduct from regulatory capital certain investments in unsecured debt instruments issued by global systemically important banks (GSIBs) that are issued for the purpose of meeting minimum long-term debt or TLAC requirements.

As noted in the FRB press release, the purpose of the rule is to limit the interconnectedness and reduce the impact from failure of the largest banking organizations.

Under the final rule, an advanced approaches banking organization treats investments in covered debt instruments as investments in tier 2 capital instruments for purposes of applying the corresponding deduction approach in the capital rule. The rule has a detailed definition of “covered debt instruments.”

Simplified Description of “Covered Debt Instrument” Definition

Covered debt instrument means an unsecured debt instrument that is issued by a GSIB1  where the instrument is eligible for use by the issuer to comply with an applicable law or regulation requiring the issuance of a minimum amount of instruments to absorb losses or recapitalize the issuer or any of its subsidiaries in connection with a resolution, receivership, insolvency, or similar proceeding of the issuer or any of its subsidiaries.

However, for purposes of this definition, covered debt instrument does not include a debt instrument that qualifies as tier 2 capital pursuant to 12 CFR 217.20(d) or that is otherwise treated as regulatory capital by the primary supervisor of the issuer.

GSIBs as of November 2019 [Link]:

• JPMorgan Chase, Citigroup, HSBC, Bank of America, Bank of China, Barclays, BNP Paribas, Deutsche Bank, Goldman Sachs, Industrial and Commercial Bank of China, Mitsubishi UFJ FG, Wells Fargo, Agricultural Bank of China, Bank of New York Mellon, China Construction Bank, Credit Suisse, Groupe BPCE, Groupe Crédit Agricole, ING Bank, Mizuho FG, Morgan Stanley, Royal Bank of Canada, Santander, Société Générale, Standard Chartered, State Street, Sumitomo Mitsui FG, Toronto Dominion, UBS, UniCredit

An advanced approaches banking organization may exclude from deduction investments in certain covered debt instruments up to five percent of its common equity tier 1 capital, as measured on a gross long basis. For US GSIBs, positions eligible for the five percent exclusion are covered debt instruments that are held for market making activities. For other advanced approaches banking organizations, all covered debt instruments are eligible for the five percent exclusion.Deduction from capital is required under several instances, including for investments in covered debt instruments that, together with investments in the capital of unconsolidated financial institutions, exceed ten percent of the investing advanced approaches banking organization’s common equity tier 1 capital.

The final rule applies to both direct and indirect investments in covered debt instruments. Indirect exposures include investments in an investment fund that holds a covered debt instrument. Under the broader regulatory capital rules, Separate Account BOLI exposures are considered investment fund exposures.

Any investments in covered debt instruments that are not subject to deduction under this rule must be assigned the appropriate risk weight under the capital rules.

The final rule is effective 4/1/2021.

1 In general, this includes GSIB BHCs, or certain intermediate holding companies of such GSIB BHCs, or GSIB banking organizations, or a subsidiary of GSIB banking organizations).

TAX DEVELOPMENTS

IRS Private Letter Ruling Regarding Investor Control Doctrine

On October 9, the IRS publicly released PLR-103588-20. This PLR modifies a prior letter ruling (PLR-103536-12) issued in May 2012.

Brief Overview of 2012 PLR

A life insurance company (Taxpayer) that issued group annuity contracts based on segregated asset accounts (collectively, the “Separate Account”) sought rulings on who would be considered the owner of the Separate Account assets for federal income tax purposes following a proposed restructuring. With respect to the Separate Account, the Taxpayer issued two types of contracts: (1) Pension Contracts; and (2) Non-Pension Contracts.

All funds in the Separate Account were invested in real estate investments. Taxpayer held some of the Separate Account assets directly, and other assets indirectly, through wholly-owned subsidiaries that were disregarded entities for federal income tax purposes (“Disregard 1” and “Disregard 2” respectively).

Taxpayer planned to restructure its Separate Account for non-tax reasons as set forth in the ruling. The effect of the restructuring was different for owners of Pension Contracts versus owners of Non-Pension Contracts.

The IRS affirmed that the owners of Pension Contracts would not be treated as owners of the Separate Account 1 assets for federal income tax purposes. However, the Non-Pension Contracts (after the restructuring) would hold interests only in a single entity, the interests of which would be available for purchase by the general public. As such, the owners of the Non-Pension Contracts would be treated as the owners, for federal income tax purposes, of the Separate Account 2 assets.

Updated PLR

In the updated PLR, the Taxpayer provided one additional representation to the IRS (in general, that it would maintain a certain amount of other assets in Separate Account 1 other than its ownership interest in Disregard 1).

The analysis section of the PLR was modified. Of note, the IRS described the two prongs that could cause the holder of a variable contract to be treated as the owner of the assets held in the separate account: (1) the investor control prong; and (2) the public availability prong.

The Ruling further described the public availability prong:

The public availability prong of the investor control doctrine generally provides that when the sole asset held by a separate account is available for purchase other than through the purchase of variable annuity or life insurance contracts, or other variable contracts from insurance companies, the contract holder will be treated as the owner of the asset held by the separate account. See Rev. Rul. 81-225; Rev. Rul. 2003-92. In such circumstances, the contract holder’s position is substantially identical to what his or her position would have been if he or she had directly or indirectly (as in Situation 4 of Rev. Rul. 81-225) purchased an interest in the asset held by the separate account.

The rulings set forth in the PLR were largely unchanged.

LEGISLATIVE DEVELOPMENTS

SAFE DATA Act Introduced in the Senate

On September 17, Senator Roger Wicker (R-MS) introduced the SAFE DATA Act (S. 4626). This proposed legislation would establish comprehensive data privacy and data security protections for consumers in the US.

An overview of this proposal has been published on the International Association of Privacy Professionals (IAPP) website.

New Jersey Enacts Law Prohibiting STOLI

On October 19, the NJ legislature enacted a law (AB 1263) defining “stranger-originated life insurance” or “STOLI” and prohibiting such practices. It does not appear to have any impact on the permissibility of employer-owned life insurance programs.

The law defines STOLI as follows:

“Stranger-originated life insurance” or “STOLI” means an act, practice or arrangement to initiate or procure the issuance of a policy in this State for the benefit of a third-party investor who, at the time of policy inception, has no insurable interest under the laws of this State in the life of the insured.

STOLI practices shall include, but shall not be limited to, cases in which: (a) a policy is purchased with resources or guarantees from or through a person or entity who, at the time of policy inception, could not lawfully initiate or procure the policy himself, herself, or itself; and (b) at the time of policy inception, there exists an arrangement or agreement, to transfer, directly or indirectly, the ownership of that policy or the policy benefits to a third party.

The law also allows a life insurer to contest a life insurance policy on the grounds that it was obtained by a stranger-originated life insurance practice at any time.