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Insolvency, Creditors' Rights & Financial Products Alert >> Marketplace Lending Regulatory Landscape Begins to Take Shape with the OCC’s Plans for a National Charter

December 7, 2016

In a move that could greatly reduce the uncertainty in marketplace lending created by the decision of the U.S. Court of Appeals for the Second Circuit in Madden v. Midland Funding, LLC and the potential for exposure under state usury laws, on December 2, 2016, the Office of the Comptroller of the Currency (OCC) released a white paper fully endorsing the granting of special purpose national charters to financial technology companies, allowing them to bypass state usury laws under the National Bank Act’s (NBA) preemption rules.

Despite the significant benefits to marketplace lenders, however, the OCC appears ready to use its plans for a fintech national charter as a means to address concerns of consumer groups and the perceived need for greater regulatory oversight in the industry. Accordingly, lenders will need to weigh the benefits of a charter against the regulatory burden it may impose.

The Need for a National Charter
As we reported in a previous D&G Alert, the Madden decision has created uncertainty for marketplace lenders that use a bank origination model relying on a partnership with an FDIC-insured state-chartered bank. Through such a partnership, the lender seeks to benefit from the bank's ability to preempt state usury laws under the Federal Deposit Insurance Act (similar to the NBA), thus avoiding compliance issues related to varying state usury statutes and enabling the lender to offer a uniform product to investors. Under Madden, however, the pass-through of preemption from the bank to the marketplace lender arguably applies only when the selling bank maintains an ongoing economic interest in the loans sold. This created the potential for marketplace lenders to be exposed for unenforceable interest rates and monetary penalties if the usury laws of the state of the borrower were to apply. Some marketplace lenders have changed the structure of transactions in response, but not without additional uncertainty and added costs.

Under the OCC's proposal, if granted a special purpose charter under the NBA, a marketplace lender will not need to ensure compliance with each state's usury laws or utilize the charter of a funding institution (and concurrently take on additional risks of compliance and regulatory issues) in order to utilize the statutory preemption rules available to banks.

New Regulatory Considerations for Newly Chartered Lenders
Going forward, although it is unclear what specific actions may be required as part of the approval process, it is certain that a chartered entity will be subject to many of the same regulatory agency oversights as any national bank, including the Federal Reserve System, the Federal Deposit Insurance Corporation (to the extent the company is deemed to accept deposits), and the Consumer Financial Protection Bureau. Further, the chartered entity will be subject to the same OCC supervisory expectations as any national bank, such as business plan submission at application, proper governance structure, minimum and ongoing capital requirements, liquidity evaluations and compliance risk management.

In a nod to consumer groups that have voiced their concerns regarding marketplace lending and financial technology companies generally, the OCC showed that it is keenly aware of the competing views of those who see a national charter and the federal preemption possibilities as anti-consumer, and those who believe innovation and credit availability created by marketplace lenders will outweigh any detriment to consumers. In particular, the OCC has indicated that business plans for lending companies will need to explain the company's "commitment to financial inclusion." Recognizing that most marketplace lenders will not be subject to the Community Reinvestment Act, which requires an FDIC-insured institution to serve the credit needs of its community, the agency will require charter applicants to define their relevant market, how their products and services will promote financial inclusion and how their practices are "designed to ensure" those items are "offered on a fair and non-discriminatory basis."

It appears there will be no requirement that non-banks offering bank-like services apply for a charter. Instead, the application process will be a choice that the OCC expects to be "driven by the company's business model and strategy on how best to serve their intended customers." For marketplace lenders, that choice will also need to encompass consideration of the regulatory impact of becoming a chartered entity relative to the regulatory framework that ultimately becomes applicable to marketplace lenders generally – a framework that remains very much under construction and uncertain, particularly with a Trump administration.

Bottom Line

The OCC's plan for a fintech national charter alleviates some of the uncertainty felt by marketplace lenders in the wake of Madden v. Midland Funding, LLC. However, in determining whether to seek chartered status, marketplace lenders must weigh the benefits, including the ability to avoid state usury laws, against the regulatory burden that comes with chartered status.