Pivoting to a Post–Silicon Valley Bank Regulatory Regime
Rigorous banking regulations might be on the horizon, but companies are already responding to a changing financial services environment.
Silicon Valley Bank failed on Friday, March 10, after a run on deposits spurred by the bank’s sudden call to raise $2 billion in capital. That weekend, many of the attorneys at Orrick Herrington & Sutcliffe didn’t sleep.
“We had a lot of friends saying things like ‘Sorry you had to miss that birthday party’ or sleep, etc.,” said Shawn Atkinson, co-leader of Orrick’s global technology companies group. “But this is cutting-edge work, and while we’re not pleased to be missing those things, dealing with the collapse of something that caused massive chaos and unrest with our friends, colleagues, and clients, we are here for them and we feel privileged to be part of the solution.”
More long days might still be ahead for regulatory, technology, and financial services attorneys amid calls for more stringent regulations to prevent similar bank failures in the future. There are a number of ways the regulations might take shape—many of which could transform bank-client relationships.
The Potential Regulatory Landscape
Since the collapse of Silicon Valley Bank and Signature Bank, the White House has pushed for proposed rules for midsize banks with between $100 billion and $250 billion in assets. The Biden administration is advocating for regulators to require these banks to hold more liquid assets, increase their capital, submit to regular stress tests, and write living wills. Michael Barr, the Federal Reserve’s vice chair of supervision, also signaled before Congress that the agency is considering stronger banking rules, such as tougher liquidity and capital requirements.
New Jersey– and Pennsylvania–based Christopher Pippett, chair of Fox Rothschild’s financial services industry practice, predicts that regulators and legislators will look to require banks to move more quickly when they have liquidity issues. But he warns that the response could be a knee-jerk reaction.
“Frankly, a lot of financial institutions have been wrestling with liquidity issues for the last 18 or so months,” following the pandemic, government stimulus funding, and then inflation, he said. That caused liquidity issues with banks that hadn’t traditionally had them. “If you add that to the fact that they had also been lending because interest rates were so low, probably at record paces, it just was the perfect recipe for liquidity issues, which is why financial institutions, large and smaller, right now are wrestling with those issues,” he said.
Christopher Paridon, a Washington, D.C., partner at Morgan, Lewis, & Bockius, said regulators might say they are statutorily prohibited from rewinding the clock back to 2018 and will not be able to push down requirements to banks with between $50 and $100 billion in assets. But he could see regulators really tailoring and applying enhanced prudential standards for banks with more than $100 billion in assets.
Paridon, who focused on the implementation of the Dodd-Frank Act while working in the legal division of the Federal Reserve System’s board of governors, said regulators might not only put some requirements back on firms with between $100 billion to $250 billion in assets, but also increase the stringency for larger firms with more than $250 billion in assets.
Silicon Valley Bank’s downfall has also raised a separate question about how the Federal Reserve will handle regulation for firms that are transitioning between different asset categories in the regulatory framework. As a firm outgrows its existing categorization level, “there’s a transition period where you can see a lag in terms of firms becoming what some people might call riskier, but not yet having to actually undergo the same level of supervisory scrutiny for a year or two,” Paridon said.
Grant Butler, a K&L Gates partner in Boston, said it will be more interesting to see what changes might also come down on banks under the $100 billion threshold, such as interest rate or liquidity management, and what’s held as an available for-sale security versus what’s held to maturity.
“I think some changes are going to impact the entire banking industry, and those changes may come in the form of regulation or they may come in just the way that supervision is conducted,” said Butler, who advises on regulatory issues related to the Dodd-Frank Act.
Where attorneys might really see changes that affect all banks is the reviews of the supervisory processes at the Federal Reserve and Federal Deposit Insurance Corp. (FDIC), he said. For instance, scrutinizing large amounts of uninsured deposits, long-dated loans, or low-interest-rate bond portfolios—some of the defining attributes that led to the failures of Silicon Valley Bank and Signature Bank—could also be a target for regulators across all financial institutions, he said.
Another policy that attracted negative attention during Silicon Valley Bank’s tailspin was its deposit covenant requiring 100 percent of borrowed funds to be parked at Silicon Valley Bank. The covenant, which is a common demand, might face some pushback going forward, either from bank clients or regulators.
Butler said he has had many conversations with clients who were subjected to Silicon Valley Bank’s deposit covenant. “Now, amongst borrowers, there’s a real enhanced awareness and concern about agreeing to have all your banking relationships with one institution, and that is not what boards and managers and CFOs want to do,” he said. But Butler said he hasn’t heard of regulators attempting to address the issue and feels agencies should regulate terms of commercial contracts and lending.
Paridon, however, said both depositors and regulators could address the covenant. “I’d be surprised if regulators weren’t looking at these types of covenants and saying, depending on the wording and the substance, are these consistent with existing anti-tying principles?”
Paul Hughes, Wiggin and Dana’s former managing partner and emerging companies and venture capital (VC) practice group co-chair, said he could also see regulators taking a look at 100 percent deposit covenants, but their involvement could have big effects on lending generally.
“It’s one thing to say you can’t do it, because then lenders can say ‘I’ll give you half as much,’” Hughes said. “That’s a lot of sand in the gears of commerce. I hope the Fed is paying attention more broadly. I think an easier solution, rather than tinkering with covenants, is just for the Fed to guarantee deposits to a more reasonable number.”
Whether regulators will also put in place the “21st century equivalent of a bank holiday” to slow down outflows of deposits, expedited through banking apps and social media, also remains to be seen, according to Butler. “Is there something within the mechanics of the electronic transfer systems, or where the regulators prior to a failure can just slow this outflow of cash and also the self-fulfilling prophecy broadcast across social media of needing to get your money out of a bank?” he asked. “I don’t know exactly what that would look like that would be effective or comply with the First Amendment, but I think there needs to be thought about that because the speed at which deposits can outflow is definitely an important concern coming out” of the failures.
New regulations could have a tightening effect on lending from the banking sector and potentially reduce financial institutions’ profitability, Butler said.
A Changing Ecosystem
Silicon Valley Bank was in a category of one in serving the venture capital industry. Its long-term investment in the sector made it a household name, and with its collapse, lawyers said it will bring disruption in the marketplace.
The venture industry “lost the bank that was really focused on them,” Butler said, noting their deposit base proved to be flighty. “That may impact [startups’] ability to have the same kind of tailored banking services they used to receive from some bank,” he said, especially if more money ends up at large banking institutions.
Many lawyers reported their clients moved money to big banks, along with some community banks or private lenders. Quarles & Brady partner Adam Falkof noted that for many clients, these decisions were implemented in a matter of hours or days. “It’s not of our fear of losing money because of what the FDIC did,” Falkof said. “It’s fear of inaccessibility.” The concern is: “Can I get my money on Friday for payroll?”
In the wake of the bank failure, “high-flying startups were realizing their morbidity,” said Evan Kipperman, the co-chair of Wiggin and Dana’s emerging companies and venture capital (ECVC) practice. Even though initial concerns around payroll and business operations quickly subsided, Kipperman said the collapse ushered in concerns about startups’ banking habits.
“I’m having more conversations around banking relationships than I’ve ever had before. Some of the larger venture-backed companies are realizing it’s time to mature and they need a controller in place to help diversity their cash strategy,” Kipperman said, noting one of his clients is revamping its entire finance team.
Some lawyers predicted that other community banks will take more market share because startups aren’t the ideal big-bank client, while others said the more challenged piece of the puzzle is SVB’s lending business.
“It’s really the venture financing component where SVB was second to none,” Kipperman said. “If you ask whether or not that needs to be replaced? Yes, but I’m not sure where. I think you’ll see more equity financings without cheaper money to supplement financing rounds.”
Michael Gray, a partner at Neal Gerber & Eisenberg, agreed. “The debt deals [SVB] did are going to be tough to replace,” he said. “Although the opportunity is as good as it gets right now to get business, there isn’t enough capital on the balance sheet at other players to move debt to banks in the marketplace. We’ll see less credit, more equity until the market clears.”
Falkof said, in the short term, that puts additional pressure on startups. “We’ve seen VCs become much more nervous about the funding environment,” he said. “Startup investing is already highly speculative. When you think about the risk, there are three dials: the idea, the team, and the economy. With that third dial—the economy—cranked all the way up, that means investing strategically is monumentally riskier than it was six months ago.”
But it isn’t all doom and gloom, lawyers said, noting that others will surely step up to fill the gap for SVB in the lending space.
“It’s such an attractive and necessary piece of the ecosystem that it will be filled because people will step in,” Cooley CEO Joe Conroy said. “I can’t imagine it’ll put a fundamental dent in growth. I’m a believer in some adjustments, some dislocation in that market. … But we’ll be on top of assisting clients and taking advantage of whatever is the next challenge.”
Wiggin and Dana ECVC co-chair Len Gray said not one but five entities should replace SVB. “It wasn’t a good choice for our industry to have so much concentration in one place, anyway,” Gray said. “I think the market works best when there are choices. If you get five different folks picking off some of SVB’s work, to me you’re better off that way.
“In our world, an idea gets frothy and everybody swarms to it,” Gray continued. “That usually leads to a crescendo and then a washing away which takes some folks with it. As our industry matures, we’ll be better off with less frothiness, more options, and more stability industrywide, as opposed to everyone chasing the same rabbit.”
From: The National Law Journal