By: Mark A. Mangano and
Serving customers engaged in growing, cultivating, handling, or processing industrial hemp presents significant opportunities. But it presents heightened risks that require special care. A banker considering these opportunities must be aware of legal authority, Bank Secrecy Act (BSA), and credit risks associated with a new and rapidly expanding industry.
The cultivation, processing, and sale of industrial hemp, and its byproducts, has grown rapidly in Kentucky since its legal reintroduction in 2014. According to the Kentucky Department of Agriculture (KDA), the number of planted acres of hemp has exploded from 33 acres in 2014 to 26,500 acres in 2019.
The Federal rules relating to legally growing and banking hemp became much clearer in 2019. The USDA published an interim final regulation governing growth and production of hemp and banking regulators issued a statement clarifying the Suspicious Activity Report (SAR) filing requirements. However, regulation of the Kentucky hemp industry is in a state of transition in 2020.
Legal authorization
Federal
For decades production of hemp in the United States was illegal because it was not legally distinguished from marijuana which is a Schedule I controlled substance under the Controlled Substances Act. Marijuana is a name used to describe the plant Cannabis sativa L. Marijuana contains the psychoactive chemical, tetrahydrocannabinol (THC). However, it is possible to breed Cannabis sativa L. plants that have very low levels of THC.
The Agricultural Act of 2014 (Agricultural Act) created a definition of “industrial hemp” and authorized pilot programs to study the growth, cultivation, or marketing of industrial hemp.1 The Agricultural Improvement Act of 2018 (2018 Farm Bill)2 removed hemp from Schedule I of the Controlled Substances Act by defining hemp as “the plant Cannabis sativa L. and any part of that plant…with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis.”3
On October 31, 2019, the USDA published an interim final rule setting forth the framework for regulating the production of industrial hemp.4 The interim final rule addresses the minimum standards for the regulation of the hemp production industry by states and provides a federal system for regulating hemp growers in states that have authorized hemp production but do not choose to administer the regulation of the industry.
State
The cultivation, processing and marketing of hemp in Kentucky is conducted pursuant to an industrial hemp research pilot program as authorized by the Agricultural Act.5 KDA exercised its authority to promulgate guidance for licensed growers, licensed processors, and affiliated university researchers which primed the industry for growth through the removal of regulatory uncertainty.6
On January 21, 2020, the KDA announced that it would continue the hemp research pilot program through the 2020 growing year. The KDA has indicated its intention to use 2020 as a year to transition from a hemp research pilot program to a commercial hemp program. Transitioning from a hemp research pilot program will require action from the General Assembly to permit and regulate production of industrial hemp consistent with the 2018 Farm Bill authorization. House Bill 236, signed by the Governor on February 10, 2020, is part of this transition as it removed “pilot” language from existing statutes while also allowing Kentucky to expand its testing procedures and clarifying language that regulates the transportation of hemp material versus extract.7
BSA
On December 3, 2019, federal regulatory agencies, including the FDIC, the Federal Reserve’s Board of Governors, and the Financial Crimes Enforcement Network (FinCEN), in collaboration with the Conference of State Bank Supervisors issued the statement “Providing Financial Services to Customers Engaged in Hemp-Related Businesses” (Statement).8 The Statement makes clear that banks are not required to file a SAR on customers solely because they are engaged in the growth or cultivation of hemp in accordance with applicable laws and regulations.
The Statement reaffirms the continued requirement that banks maintain BSA programs that address customer identification, suspicious activity reporting, currency transaction reporting, and risk-based customer due diligence, including the collection of beneficial ownership information for legal entity customers.
On June 29, 2020, FinCEN issued new guidance “FinCEN Guidance Regarding Due Diligence Requirements under the Bank Secrecy Act for Hemp-Related Business Customers”9 to help banks better understand how to conduct due diligence for hemp-related businesses and identify the types of information and documents banks can collect to comply with BSA regulatory requirements. The guidance augments the instructions provided in the Statement related to BSA documentation and suspicious activity reporting. The guidance applies only to hemp-related businesses and does not apply to marijuana-related businesses.
Credit Risk
The industrial hemp industry in the United States is in a fledgling state. This presents increased risks for those producing hemp. Most hemp producers have no more than a few years of experience. As with any credit decision, it will be important to not only know your customer but also understand the industry.
Some of the credit risks include:
- Producing a crop that violates the THC limits of state and federal law;
- Uncertain demand for hemp;
- Oversupply of hemp that depresses prices;
- Volatility in the CBD market; and
- Future regulation of hemp products that limit demand or increase costs.
There is great optimism around the expansion of the industrial hemp industry in Kentucky. Regulatory developments continue to reduce but do not eliminate the special risks related to banking hemp businesses.
1 7 U.S.C. 5940
2 Pub. L. 115-334, 132 Stat. 4490.
3 7 U.S.C. 1639o(1).
4 7 CFR 990.
5 KRS 260.858
6 302 KAR 50:020, 302 KAR 50:030, and 302 KAR 50:040
7 https://apps.legislature.ky.gov/recorddocuments/bill/20RS/hb236/bill.pdf
8 https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20191203a1.pdf
9 https://www.fincen.gov/sites/default/files/2020-06/FinCEN_Hemp_Guidance_508_FINAL.pdf