Introduction Congress chartered Fannie Mae and Freddie Mac, also known collectively as the government-sponsored enterprises (GSEs), to promote homeownership by providing liquidity to the secondary markets for single-family residential mortgages and multifamily (apartment and condominium) construction. Guaranteeing single-family residential mortgages is their core business activity, but it comes with risks. The GSEs retain the credit (default) risks from the mortgages they purchase from loan originators and subsequently issue mortgage-backed securities (MBSs), which are bond-like securities. Investors who purchase the MBSs are guaranteed to get their initial principal investment returned, but they assume the risk that borrowers may choose to repay their mortgages ahead of schedule, known as prepayment risk. The MBSs are considered more liquid (in comparison to the original mortgages with both attached risks) because they may be traded or sold for cash more quickly. If investors are willing to hold MBSs, then more private-sector funds become available for relatively less liquid mortgagesâparticularly 30-year fixed-rate mortgages. National mortgage rates tend to fall as the supply of funds in this market increases, making homeownership more affordable. The Federal Housing Finance Agency (FHFA), an independent federal government agency created by the Housing and Economic Recovery Act of 2008 (HERA; P.L. 110-289 ), is the GSEs' primary supervisor. FHFA regulates the GSEs for prudential safety and soundness and ensure they meet their affordable housing mission goals. In September 2008, the GSEs experienced losses that exceeded their statutory minimum capital requirement levels due to the high rate of mortgage defaults. The GSEs also experienced losses following spikes in short-term borrowing rates that occurred while they were funding long-term assets held in their portfolios. The GSEs subsequently agreed to be placed under conservatorship. Until the GSEs' financial safety and soundness can be restored, the FHFA has the powers of management, boards, and shareholders. The FHFA established three conservatorship performance goals designed to restore confidence in the GSEs and restore them to a safe and solvent condition: 1. The GSEs must promote a well-functioning national housing finance market while operating in a financially safe and sound manner. 2. Credit or default risk to U.S. taxpayers should be reduced by increasing private capital's role in the mortgage market. 3. The GSEs must construct a contemporary singleâfamily securitization infrastructure for their use and other private mortgage securitizers. In addition, the Senior Preferred Stock Purchase Agreements (PSPAs) stipulate the conditions under which the U.S. Treasury will provide financial support to the GSEs while they are under conservatorship. The PSPAs require the GSEs to pay dividends to Treasury rather than private shareholders while they are under conservatorship. The PSPAs also require the GSEs to reduce the size of their lending portfolios to $250 billion. Since they entered conservatorship, congressional interest in the GSEs has continued due to uncertainty in the housing, mortgage, and financial market. For example, the final amount and duration of financial support that Treasury will eventually provide the GSEs is difficult to predict at present. Furthermore, reforming or replacing the GSEs might affect the availability of single-family 30-year fixed-rate mortgage loan products. This mortgage product is arguably popular with borrowers, but private lenders may be reluctant to retain them in their lending portfolios because they are relatively less liquid mortgagesâwith both credit and prepayment risks attachedâand may last for several decades. Congressional interest has been reflected by various draft proposals, bills, and oversight hearings on housing finance reform. During the 116 th Congress, the U.S. Senate Committee on Banking, Housing, and Urban Affairs released a proposal that would affect the GSEs' role in the housing finance system. President Donald J. Trump also released a memorandum directing federal agencies to develop a plan to reform the housing finance system, which includes ending the conservatorships. This report first describes Fannie Mae's and Freddie Mac's activities and mission. It then summarizes the progress made to date on FHFA's initiatives, focusing primarily on the management of the GSEs' credit and liquidity risks. The FHFA has directed the GSEs to share more of the credit risk linked to their single-family mortgage purchases with the private sector to reduce potential risks that would be borne by U.S. taxpayers. The GSEs must also standardize numerous processes to foster greater liquidity in the market for their MBSs. This report concludes with a discussion of the policy implications of GSE challenges while they are under conservatorship. For example, recent FHFA initiatives require the GSEs to harmonize their business models, including certain borrower risk characteristics that are eligible for securitization. The GSEs' ability to satisfy their affordable housing goals, therefore, might depend upon the extent to which borrowers with risk characteristics deemed eligible for securitization overlap with those who traditionally face greater difficulty accessing mortgage credit. In addition, the GSEs' ability to purchase and securitize mortgages may depend upon certain legal protections that loan originators receive when their mortgages are sold to the GSEs. The regulation, which is known as the GSE patch (or QM patch), expires on January 10, 2021, and it is difficult to predict how secondary-market participantsâloan originators, the GSEs, and investorsâwill respond if it expires as scheduled. The GSEs' Secondary Mortgage Market Intermediation Activities Borrowers obtain their mortgages from loan originators in the primary market; loan originations may be bought and sold in the secondary market. By law, the GSEs cannot originate mortgages directly to borrowers in the primary market. Instead, the GSEs operate in the secondary mortgage market, interacting with loan originators (that sell mortgages to the GSEs) and investors (that purchase the GSEs' debt and MBS issuances). The GSEs purchase conforming mortgages , single-family mortgages that meet certain eligibility criteria based on size and creditworthiness, from loan originators. The GSEs use two methods to acquire conforming mortgages. A GSE may pay cash directly from its cash window to a loan originator for delivery of a small number of mortgages. Alternatively, the GSEs may enter into a swap agreement with a loan originator to purchase a large number (pool) of mortgages. In exchange for a pool(s), the purchasing GSE delivers one (or more) MBS that is linked to the MBS trust that will hold the mortgages. An MBS trust is a legal entity established to hold pools of conforming mortgage loans; the streams of principal and interest are deposited as borrowers repay their mortgages. The GSEs issue MBSs to investors. MBSs are essentially derivative products that contain one, rather than both, of the financial risks attached to the original mortgages that the GSE purchased. Investors that purchase an MBS receive a coupon , which is the yield composed of the principal and interest repayments from borrowers whose mortgages are held in MBS trusts. However, various fees are subtracted before the coupons are paid to investors. For example, a designated mortgage servicer retains a fee to collect borrowers' regular payments, resolves borrower delinquency and default problems, and disburses payments to the GSEs (which subsequently disburse payments to MBS investors). Other fees related to the home purchase (e.g., settlement costs) that borrowers may have chosen not to pay upfront may also be subtracted. Simply put, the coupon is the rate of return net of fees that an investor receives for purchasing or investing in an MBS. The GSEs, like banks, are financial intermediaries that match mortgage borrowers with ultimate lenders. Under a traditional banking model, banks borrow funds from their depositors and use the funds to originate longer-term consumer and business loans. Consumers and businesses pay higher interest rates to banks for these longer-term loans than the banks pay to their depositors for successive sequences of relatively lower-rate loans (e.g., recurring deposits) for shorter periods of time. L ending spreads are the difference between lending at higher rates (revenues) and borrowing at successive sequences of shorter rates (costs). A bank can retain all of the profits generated by its lending spreads if the entire lending process and associated financial risks are retained on its balance sheet. Similar to banks, the GSEs create profitable lending spreads to finance assets retained in their lending portfolios (on-balance sheet) and the conforming mortgages held in the MBS trusts (off-balance sheet). The GSEs issue to investors debt securities, referred to as unsecured debentures , with shorter maturities relative to the longer-term assets retained in portfolio. By borrowing via successive sequences of lower-rate debentures, the GSEs create portfolio lending spreads. In addition, the GSEs fund mortgages held in the MBS trusts. Rather than issuing debentures, the GSEs fund the MBS trusts via issuing MBSs in the to-be-announced (TBA) market. When issuing MBSs, however, the GSEs act more like monoline bond insurers, meaning they retain credit risk and transfer prepayment risk to private investors. These concepts, which are key to understanding the GSEs' securitization activities, are described in detail in the sections below. Retention of Mortgage Credit Risk, Transfer of Prepayment Risk Another important fee, the guarantee fee (g-fee) , is deducted from the streams of principal and interest payments before an MBS investor receives a coupon payment. The g-fee compensates the GSEs for retaining credit risk , the risk that borrowers might default or fail to repay their mortgage loan obligations. Although the g-fee is typically charged to loan originators (and frequently passed onto borrowers), the benefit of the mortgage insurance accrues to MBS investors. Should a delinquency or default occur, the GSEs guarantee timely payment of the coupon (net of fees) to MBS investors. After a borrower defaults, the applicable GSE purchases the defaulted mortgage (for the amount of the remaining balance owed) out of the MBS trust. The purchase effectively reimburses the associated MBS trust and, therefore, prevents MBS investors from losing their initial principal investments. The MBS coupon is subsequently adjusted for the reduced stream of interest payments, thus making it appear to investors that mortgage obligations have been repaid ahead of schedule (rather than defaulted). The other key mortgage risk, prepayment risk , is transferred from the GSEs to MBS investors. Prepayment risk is the risk that borrowers will repay their mortgages ahead of schedule, resulting in lenders earning less interest revenue than initially anticipated. For example, if mortgage rates decline, some borrowers may repay their existing mortgages early by refinancing (replacing) them into new mortgages with lower rates. Borrowers also prepay their mortgages when they move. In this case, the GSEs pass on the principal repayment but reduce the investors' MBS coupons by the amount of interest forgone. In sum, the GSEs' securitization process entails detaching two mortgage risks into separate components. The GSEs retain the default risk component for a g-fee and transfer the prepayment risk component to MBS investors. For this reason, MBSs are considered derivative securities because they contain only one of the risks linked to the original underlying mortgages held in the MBS trusts. Liquidity Risk in the Markets for MBSs Many types of bonds and derivatives trade directly (via broker-dealers) between two parties in what are referred to as over-the-counter (OTC) market transactions. Bonds generally trade infrequently, and the trade sizes vary, which may cause valuation (pricing) challengesâsometimes leading investors and market-makers to perceive that the bonds may be illiquid . Illiquid securities cannot easily be converted into cash or traded within a reasonable time, that is, without affecting their quoted prices. Investors arguably might offer (bid) "too much" to buy or sell (ask) for a price "too low" when trading illiquid securities. Consequently, investors require additional compensation, referred to as a liquidity premium , to buy or sell illiquid securities. Widening bid-ask spreads might signal the emergence of a liquidity premium being incorporated in securities prices. After being issued in the TBA market, the GSEs' MBSs trade in the OTC market and are considered to be almost as liquid as the U.S. Treasury bond market. Prior to conservatorship, the GSEs could actively trade their own MBSs to facilitate market liquidity. By conducting market trades when the bid-ask spreads for MBS widened, the GSEs could abate rising liquidity premiums and reduce mortgage costs for borrowers. Persistent liquidity premiums could result in higher mortgage rates for borrowers if investors demand greater compensation to account for the risk of selling their MBSs in the future for a price presumed to be too low. Furthermore, the TBA market is a forward market, meaning MBSs are purchased in advance of a specific future date. Investors wanting to hedge against adverse interest rate movements prior to delivery of their MBS purchases would, therefore, pay higher costs to cover the possibility of liquidity premiums emerging before the settlement date. Investors' larger hedging costs could also be passed on to borrowers wanting to lock in interest rates for a period of time prior to closing on their mortgages. Hence, high-volume trading by the GSEs facilitated narrower bid-ask MBS spreads in both the TBA and OTC markets. (The GSEs held their own MBSs to show incentive alignment with investors, meaning the GSEs were willing to hold the same risks that they were selling.) The current $250 billion cap on the GSEs' lending portfolios (resulting from the PSPAs) may limit their ability to buy and sell MBSs at the volumes necessary to influence market pricing. Although the Federal Reserve has purchased large amounts of the GSEs' MBS while carrying out its lender-of-last-resort responsibilities, it has largely retained them in its portfolio rather than actively trading them. Hence, less active trading of MBSs by the GSEs and more holding (rather than actively trading) of MBSs by the Federal Reserve might explain any declines in market liquidity. FHFA's Initiatives for the GSEs Under Conservatorship Since conservatorship, the FHFA has focused primarily on (1) the credit risks retained by the GSEs (posing a direct risk to U.S. taxpayers) and (2) the liquidity of their MBS issuances. The FHFA has released various versions of strategic plans and performance goals to inform the public. This section highlights FHFA initiatives that focus on those specific risks. Initiatives Regarding the GSEs' Credit Risks As previously mentioned, the PSPAs require the GSEs to pay dividends to the U.S. Treasury in exchange for its financial support while they are under conservatorship. The PSPAs also require the GSEs to reduce taxpayers' credit risk. The FHFA has subsequently required the GSEs to increase the private sector's role in credit risk sharing. The various programs to facilitate these objectives are discussed in this section. Loan-to-Value Requirements for Borrowers By statute, additional credit enhancements (discussed in the next paragraph) are required if the GSEs purchase mortgages with a loan-to-value (LTV) above 80% such that the mortgage balance exceeds 20% of the residential property value. If a borrower defaults, the GSE generally recovers losses by foreclosing (repossessing) and then liquidating (selling) the property. The 80% LTV requirement ensures that a property would need to sell for at least 80% of its original value for the GSE to recover enough proceeds to cover the remaining mortgage balance. Borrowers lacking sufficient funds to make a 20% downpayment have alternative options. One option is to purchase private mortgage insurance (PMI), an insurance policy that would assume the first 20% of losses associated with a mortgage default. In this case, the FHFA currently requires the GSEs to pay PMI initially and be reimbursed later by borrowers via interest rate adjustments on their loans. The GSEs currently contract with a limited group of private mortgage insurers that accept the GSEs' underwriting standards, thereby streamlining the process to obtain PMI. Fannie Mae calls its program Enterprise-Paid Mortgage Insurance (EPMI) Option and Freddie Mac calls its program Integrated Mortgage Insurance (IMAGIN). By doing business with a select group of PMI providers, the GSEs (and FHFA) can closely monitor their financial health and ensure their ability to pay any PMI claims after borrower defaults, thus reducing counterparty risk. Guarantee Fees The GSEs can generate revenues to cover potential credit losses by increasing g-fees, thus mitigating losses to taxpayers. The GSEs have two types of g-fees. First, the upfront g-fee is determined by the borrower's risk characteristics (e.g., credit score, loan-to-value ratio). Second, the ongoing g-fee, which is collected each month over the life of the loan, is determined by the product type (e.g., fixed rate, adjustable). In December 2011, Congress directed the FHFA to increase the ongoing g-fees for all loans by 10 basis points. The increase took effect on December 1, 2012, for loans exchanged for MBSs. (A single basis point is equal to 1/100 of a percent; 100 basis points is 1%.) The FHFA also increased g-fees in 2013. In 2017, FHFA reported that the average guarantee fee of 56 basis points was unchanged from 2016. Credit Risk Transfer Programs In July 2013, the GSEs initiated new credit risk transfer (CRT) programs to share a portion of the credit risk linked to their guaranteed single-family mortgages with the private sector. Both GSEs now offer another separate set of CRT financial instruments that are linked only to the credit risk of the mortgages held in the MBS trusts. Investors preferring exposure only to mortgage prepayment risk may continue to purchase MBSs; however, the private sector may now purchase CRT issuances, which function similarly to MBSs, to earn revenue in exchange for assuming exposure to the credit risk. Fannie Mae's CRT instruments are known as Connecticut Avenue Securities (CAS); Freddie Mac's CRT instruments are known as Structural Agency Credit Risk (STACR). The GSEs transfer the credit risk linked to mortgages with LTVs greater than 60% (or borrowers with 40% or less in accumulated home equity, making them more vulnerable to the possibility of owing more than the initial value of their homes if housing market prices were to fall) to investors. After defaults occur, the GSEs write down the coupons paid to CRT investors (similar to writing down the coupons on MBSs after prepayments occur). The GSEs retain the credit risk for mortgages with lower LTVs (or borrowers with 41% or more in accumulated home equity such that their outstanding balances are significantly below the value of their residential properties), which are less likely to default. Sharing risk at both the front end (before the mortgages are purchased) via the PMI programs and the back end (after the mortgages are purchased) via the CRT programs has reduced the federal government's exposure to mortgage credit risk. The CRT programs have grown rapidly, arguably filling the gap left by the private-label mortgage-backed securities market that existed prior to 2008. Nevertheless, the Congressional Budget Office reports that the GSEs' CRT transactions have not necessarily reduced taxpayers' costs. The GSEs pay more to the private sector to assume credit risk relative to what they collect in g-fees from borrowers, and the g-fees have not been raised to cover the additional costs. Proposed Capital Framework Although the exact definition of capital for financial firms is determined by law and regulation, it generally refers to common or preferred equity (as a percentage of assets), which can absorb financial losses. The FHFA suspended the GSEs' capital requirements during conservatorship, as required by the PSPAs with Treasury. The GSEs can pay dividends only to the Treasury as opposed to private shareholders while they are under conservatorship. The FHFA has solicited feedback on how to establish a prospective capital framework for the GSEs (see text box below) that would allow them to continue operating after an event similar to the recent financial crisis. The statutory minimum leverage (unweighted) capital requirement, specified in the Federal Housing Enterprises Safety and Soundness Act of 1992, is equal to 2.5% of on-balance sheet (portfolio) assets and 0.45% of off-balance sheet (MBS trust) obligations. HERA, however, gave FHFA the authority to increase capital standards above the statutory minimum as necessary. Given the deteriorated financial conditions that caused the GSEs to be placed in conservatorship, FHFA's proposed capital framework would result in higher capital requirements. Standardization Initiatives to Foster MBS Liquidity The FHFA has introduced initiatives to standardize many aspects of the GSEs' operations, which include their mortgage data collection processes, securitization processes, mortgage servicing policies (e.g., resolving delinquencies), and MBS issuances. Such standardization arguably increases transparency, reduces the length of the single-family mortgage origination and securitization processes, and ultimately increases the liquidity and uniform pricing of the GSEs' MBS and CRT issuances. Mortgage Data Standardization The FHFA's mortgage data standardization initiative requires the GSEs to support standardizing the single-family mortgage data information used by the industry. Data collected on loan applications, property appraisals, loan closings, and disclosures are the focus of the standardization efforts. The Common Securitization Platform In 2012, FHFA determined that both technology platforms the GSEs used to securitize (the process of transferring the underlying mortgage payments into MBSs) were "antiquated and inflexible." Rather than updating two separate systems, the FHFA required the GSEs to jointly develop a new platform to facilitate the various tasks associated with their securitization processes. The GSEs entered into a joint venture, the Common Securitization Solutions (CSS), which operates the Common Securitization Platform (CSP). The GSEs continue to acquire mortgages from originators; establish separate loss-mitigation practices for delinquent and defaulted mortgages for their mortgage servicers to follow; choose the underlying mortgages for placement in each MBS trust; and guarantee the credit risk linked to the MBS trusts they individually create. The CSS, however, acts as a technology service provider for the GSEs. The Uniform MBS Single Security Initiative In the TBA market, a loan originator selling mortgages to the GSEs would contract to deliver mortgages in exchange for an MBS at a specified future date. Specifically, the MBS buyer (loan originator) and MBS seller (one of the GSEs) negotiate in advance for future delivery and settlement date. The buyer and seller agree on six general features that the MBS should have: the issuer, maturity, coupon rate, sale price, approximate face value, and settlement date. The exact features of the securities to be delivered are disclosed to the participants two days prior to settlement. MBSs that meet the required criteria can be delivered as long as the underlying MBS pools are fungible , that is, sufficiently interchangeable with other MBSs. Because the MBS issuer is one of the trading features, MBSs have generally been fungible only with other MBSs issued by the same GSE. Fannie Mae-issued MBSs and Freddie Mac-issued MBSs have not previously been interchangeable, and their MBSs do not trade at identical prices despite the fact that the GSEs have essentially the same federal charters and business (securitization) models. Freddie Mac's MBSs have been frequently traded at lower prices than Fannie Mae's. Following declines in mortgage rates that prompt borrowers to refinance, the mortgage pools underlying Freddie Mac's MBSs historically have had faster prepayment rates (relative to Fannie Mae's MBSs). Faster prepayment translates into higher prepayment risk for Freddie Mac MBS investors, which would explain trading at lower prices. The persistent price difference led to an exploitable arbitrage opportunity, particularly for large originators that sell loans via swap agreements. By entering into a swap agreement with Fannie Mae, a large mortgage originator would immediately acquire a higher-priced MBS that could subsequently be sold in the OTC market. Freddie Mac could respond by lowering its g-fees, thereby slightly increasing its MBS coupons relative to Fannie Mae's MBS coupons to remain somewhat competitive. Besides the persistent pricing differential, Freddie Mac's MBS issuances were approximately 70% of Fannie Mae's MBS issuances, and Freddie Mac's MBSs accounted for only 9% of total trading activity in 2014. Hence, the pricing differential between the GSEs' MBSsâespecially while they are under conservatorshipâis arguably transformed into a taxpayer subsidy for the larger loan originators. Under the single security initiative, the FHFA has directed the GSEs to align their key contractual and business practices by acquiring mortgages with similar prepayment speeds along with other features. The GSEs may continue to separately purchase conforming mortgages and guarantee the credit risks linked to the MBS trusts they create. Nevertheless, harmonizing the financial characteristics of their mortgage purchases would allow the GSEs' MBS trusts to generate similar cash-flow predictability and prepayment speeds, thus facilitating the creation of uniform and fungible securities when issued through the CSP. The GSEs would be required to align their prepayment speeds such that they do not constitute a material misalignment, or a divergence by more than 2% over a three-month interval. Rather than separate MBS issuances (i.e., Fannie Mae's mortgage-backed security and Freddie Mac's participation certificates), the FHFA has directed the GSEs (via the CSP) to issue one common security, the uniform mortgage-backed security (UMBSs). (Private-sector guarantors would also be able to use the CSP to issue fungible UMBSs.) The FHFA argues that a combined market for the GSEs' UMBSs would enhance market liquidity and mitigate the rise of market liquidity premiums; the pricing differential would also be eliminated. FHFA will monitor both GSEs to ensure that their underwriting policies remain intact to avoid material misalignment that compromises UMBS fungibility. UMBS issuances began on June 3, 2019. Selected Policy Implications Congress established the GSEs with a public policy mission that includes a variety of ways to support affordable housing. Following the Great Recession, Congress also established a macroprudential economic policy tool in the form of new mortgage market underwriting requirements to mitigate a systemic risk event. Given these broader public policy objectives, this section discusses selected challenges for the GSEs while they are under conservatorship. Efforts to Support Broader Access to Mortgage Credit The GSEs have statutory single- and multi-family goals along with other requirements designed to promote affordable housing. The affordable housing goals, duty to serve goals, and cash contributions make up the three sets of requirements: 1. The GSEs must satisfy specified housing goals that require them to purchase certain percentages of mortgages for families with very low incomes (at or below 50% of area median family income) and extremely low incomes (at or below 30% of area median family income). 2. HERA created a duty to serve for underserved markets, specifically manufactured housing, rural housing, and affordable housing preservation. The FHFA requires the GSEs to develop their own duty to serve plans to encourage lenders to increase their lending in these areas. 3. HERA requires the GSEs to contribute to the Housing Trust Fund (HTF) and the Capital Magnet Fund (CMF). The HTF funds states and state-designated entities for eligible activities that primarily support affordable rental housing for extremely low- and very low-income families, including homeless families. The CMF awards competitive grants to financial institutions designated as Community Development Financial Institutions and qualified nonprofit housing organizations for which the development or management of affordable housing is one of their principal purposes. The GSEs must set aside 4.2 basis points (0.042%) of the unpaid principal balance of mortgages purchased in a year for these funds. Achieving the affordable housing mission has been difficult for the GSEs while they are under conservatorship. For one reason, FHFA suspended the requirement that the GSEs make contributions to the HTF and the CMF between 2008 and 2014. The requirement was reinstated in 2015. Another factor may be that the PSPAs caps of $250 billion on both of the GSEs' portfolios potentially limit the amount of mortgages with nonstandardized characteristics they can purchase. The GSEs retained portfolios consist primarily of (1) mortgages in the pipeline to be securitized, (2) non-performing mortgages that may receive loss-mitigation, and (3) mortgages that support affordable housing mission goals. The PSPA caps and changing mortgage market conditions may prompt the GSEs to be more deliberate when allocating their portfolios for certain purposes. Under the current standardization initiatives, some mortgage purchases made to support the GSEs' affordable mission goals might not be securitized if they lack, for example, the prepayment characteristics required to be securitized into a UMBS. Hence, the standardization initiatives would not adversely affect low- and moderate-income borrowers whose prepayment speeds can be securitized into UMBSs; however, borrowers with prepayments speeds not acceptable for UMBS securitization could pay more for mortgages if the GSEs' portfolios are being used primarily as securitization pipelines for acceptable mortgages and operating closer to their PSPA caps while the GSEs are under conservatorship. The GSE Patch/QM Patch and Possible Implications for CRT On January 10, 2013, the Consumer Financial Protection Bureau (CFPB) released a final rule implementing the ability-to-repay (ATR) requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act; P.L. 111-203 ); the rule took effect on January 10, 2014. The Dodd-Frank Act requires lenders to verify a borrower's ATR with documentation. The final rule provides multiple ways for a loan originator to comply, one of which is by originating a qualified mortgage (QM). If a loan meets certain underwriting and product-feature requirements, it receives QM status; the lender receives a presumption of ATR compliance for legal purposes. Specifically, QM loans provide safe harbor legal protection, meaning that a borrower would not be able to assert that the originator (and any subsequent secondary-market purchaser) failed to comply with any of the required underwriting criteria. Limiting the borrower's debt-to-income (DTI) ratio to 43% is one of the underwriting requirements for a loan to receive QM status. If, however, a loan's DTI exceeds 43%, it may still receive QM status if another federal agency that insures mortgage credit risk is willing to guarantee it. The QM patch allows the GSEs and other federal agencies to operate under their own QM rules for seven years (until January 10, 2021) or until the GSEs exit conservatorship, whichever is sooner. Consequently, the Federal Housing Administration, U.S. Department of Veterans Affairs, and United States Department of Agriculture did not adopt a 43% DTI requirement for the mortgages they guarantee. Instead, these agencies adopted their own QM definitions, which included the exclusion of product features they considered would impede repayment from borrowers they predominantly serveâbut they did not limit DTIs to 43%. Furthermore, the CFPB's QM rule created an exemption from the 43% DTI cap for mortgages eligible for purchase by the GSEs. Hence, loan originations either acquired by the GSEs while they are under conservatorship (or until January 10, 2021) or guaranteed by other federal agencies receive QM status. Since 2007, the private-label securitizations market has diminished whereas the roles of GSEs and federal agencies that guarantee or issue residential mortgage loans have increased in importance. One reason might be related to the legal protections linked to QM loan originations. Many originators have limited themselves to making only QM loans to avoid exposure to potential liability and litigation risks. Although they may be willing to assume customary lending risks, such as credit and prepayment, financial institutions historically have been less willing to originate mortgage loans with attached compliance or legal risks. For example, since the passage of the 1994 Home Ownership Equity Protection Act (HOEPA), mortgage originations covered by the law make up a small share of the mortgage market and are concentrated among very few lenders. HOEPA lending declined markedly after new regulations were implemented to amend the definition of a high-cost mortgage to cover more types of loans. After the passage of the Georgia Anti-Predatory Lending Act of 2002, the GSEs announced that they would no longer purchase mortgages originated in the state of Georgia to avoid the legal risk of assignee liability. Likewise, many mortgage originators have reportedly limited themselves to making QM safe harbor loans. If the QM patch expires in January 2021 as currently scheduled (or the GSEs are no longer in conservatorship), it is unclear whether the GSEs would purchase non-QM loans in the future. Because the GSEs currently purchase loans that meet the QM standards, questions that pertain to the legal liabilities of the GSEs (and holders of GSE issuances) if they were to purchase non-QM loans are largely unknown at this time. If the GSEs did limit their non-QM purchases, some borrowers could find it more difficult to access mortgage credit and others could experience an increase in the cost of obtaining a mortgage. Furthermore, the MBS and CRT financial market conditions, in terms of demand, supply, and liquidity, could exhibit greater volatility after January 2021 if the patch expires.


Introduction Congress directs the U.S. Environmental Protection Agency (EPA) to implement the Renewable Fuel Standard (RFS)âa mandate that requires U.S. transportation fuel to contain a minimum volume of renewable fuel. Every year obligated parties (including small refiners) demonstrate to EPA their compliance with the mandate. The EPA may grant small refineries an exemption from the RFS for a compliance period, if they can prove compliance would subject them to disproportionate economic hardship. Over the last few years, this programmatic action, once routine, has come under increasing scrutiny from some Members of Congress and stakeholders. The debate regarding small refinery exemptions (SREs) for the RFS has intensified, as both the number of SREs granted and the total exempted volume of gasoline and diesel has increased in recent years. At the core of the SRE policy discussion are three factors: (1) the SRE statutory requirements, (2) the EPA's SRE issuance process, and (3) the impact of SREs on meeting the statutory RFS volume requirements. There are various perspectives about SREs. Some Members of Congress and stakeholders have expressed their dissatisfaction with the SREs granted under the Trump Administration. For example, some biofuel organizations argue that the method used to grant SREs, the number of SREs issued in recent years, and the accounting for the exempted fuel in recent annual rulemakings, have undercut demand for biofuel, created market uncertainty, and violated the statute, among other things. Other Members of Congress and stakeholders contend that SREs alleviate the economic burden of complying with the mandate for some refineries, that SREs do not directly impact biofuel demand, and that SREs are a symptom of a larger policy problem, among other things. This reportâin a question and answer formatâprovides information about SREs for the RFS and discusses related congressional and Executive Branch actions. More specifically, the report provides an overview of small refineries, the small refinery exemption process, challenges to EPA decisions on petitions and to its methodology for evaluating petitions, and gives a synopsis of recent RFS activity, including the new SRE projection methodology finalized by EPA. As discussed later in this report, much of the information about how EPA manages the SRE process is not publicly available because it involves confidential business information (CBI). The information provided in this report is based on a review of the statute and agency materials, as well as general knowledge about the program gleaned from various sources. The report also summarizes congressional bills that address small refinery exemptions and presents other items to consider when discussing small refinery exemptions. The report does not analyze the opportunities and challenges stakeholders may encounter from potential action taken by Congress or the Executive Branch. Frequently Asked Questions The following sections respond to 17 frequently asked questions about the RFS and small refinery exemptions. 1. What is the RFS? The RFS requires U.S. transportation fuel to contain a minimum volume of renewable fuel. The RFS statute specifies minimum annual volume targets (in billions of gallons)ârequiring 12.95 billion gallons of renewable fuel in 2010 and ascending to 36 billion gallons in 2022 ( Figure 1 ). The EPA Administrator has statutory authority to determine the volume amounts after 2022. The statute outlines the volume requirements in tables for four categories: total renewable fuel, total advanced biofuel, cellulosic biofuel, and biomass-based diesel. Both cellulosic biofuel and biomass-based diesel are a subset of advanced biofuel. Thus, the total renewable fuel statutory volume required for any given year equates to the sum of conventional biofuel (i.e., corn starch-based ethanol, which is unspecified in statute) and advanced biofuel (which is specified in statute). For each year, EPA converts the total volume requirement into a percentage standard that each obligated party must meet (based on projected gasoline and diesel consumption in that year). The statute requires that EPA regulate RFS compliance using a tradable credit system. Obligated parties (generally, refiners and importers) submit creditsâcalled renewable identification numbers (RINs)âto EPA for each gallon in their annual obligation. In short, this annual obligation, referred to as the renewable volume obligation (RVO), is the obligated party's total gasoline and diesel sales multiplied by the annual renewable fuel percentage standards announced by EPA for each category of renewable fuel. The statute gives the EPA Administrator the authority to waive the RFS requirements, in whole or in part, if certain conditions outlined in statute prevail. More specifically, the statute provides a general waiver authority for the overall RFS and waivers for two types of advanced biofuel: cellulosic biofuel and biomass-based diesel. Also, the statute requires that the EPA Administrator modify the applicable volumes of the RFS in 2016 and the years thereafter if certain conditions are met (this action is referred to by some as the RFS "reset"). 2. What is a small refinery? A refinery is a facility that converts raw materials (e.g., crude oil) into finished products (e.g., gasoline). The statute defines a "small" refinery as "a refinery for which the average aggregate daily crude oil throughput for a calendar year (as determined by dividing the aggregate throughput for the calendar year by the number of days in the calendar year) does not exceed 75,000 barrels." The statutory definition does not mention ownership. Based on the above definition, a small refinery for the RFS is any refinery that processes no more than about 3.2 million gallons of crude oil each day, or no more than about 1 billion gallons of crude oil per year. An analysis of U.S. Energy Information Administration (EIA) data for refineries based on calendar day operation appears to indicate that there were 53 small refineriesâas defined in the RFS statuteâoperating as of January 1, 2019 ( Figure 2 ). Further, EIA data appears to indicate there is a total of 132 operating refineries overall. Thus, small refineries consist of about 40% of the nation's total number of operating refineries. Additionally, the small refineries comprise about 12% of total crude oil distillation capacity in the United States. 3. What are small refinery exemptions? A small refinery exemption releases a small refinery from having to comply with the RFS mandate for a given compliance period. The exemption is only applicable to small refineries as defined in statute for the program. The statute mentions two instances whereby EPA may issue a small refinery exemption: (1) a temporary exemption and (2) an extension of the exemption based on disproportionate economic hardship. The latter instance is currently of concern to most stakeholders and is the exemption referred to in this report. The statute required a temporary exemption for all small refineries up until calendar year 2011. EPA then proceeded with an exemption for 21 small refineries for an additional two years, 2011 and 2012, based on the results of a DOE study that these small refineries would suffer a disproportionate hardship if required to participate in the program. For petitions based on disproportionate economic hardship, the small refinery itself must petition the EPA Administrator for an exemption. A small refinery may only petition for an exemption based on the reason of disproportionate economic hardship. The EPA Administrator is to consult with the Secretary of Energy when evaluating a petition. This consultation comes in the form of a DOE recommendation. EPA has the ultimate authority and may accept or reject the DOE recommendation. 4. What is "disproportionate economic hardship"? The statute does not define disproportionate economic hardship, but requires DOE to complete a study to determine if RFS compliance would impose a disproportionate economic hardship on small refineries. DOE reports that Disproportionate economic hardship must encompass two broad components: a high cost of compliance relative to the industry average, and an effect sufficient to cause a significant impairment of the refinery operations. DOE developed a scoring matrix "to evaluate the full impact of disproportionate economic hardship on small refiners and used to assess the individual degree of potential impairment . " The matrix consists of disproportionate structural impact metrics (e.g., access to capital) , disproportionate economic impact metrics (e.g., relative refining margin measure) , and viability metrics (e.g., compliance cost eliminates efficiency gains) . Congress addressed disproportionate economic hardship in the Joint Explanatory Statement accompanying the 2016 Consolidated Appropriations Act ( P.L. 114-113 ) by stating tha t "If the Secretary finds that either of these two components [from the DOE March 2011 Small Refinery Exemption Study] exists, the Secretary is directed to recommend to the EPA Administrator a 50 percent waiver of RFS requirements for the petitioner." In report language for the 2017 appropriations bill for EPA , C ongress direct ed EPA to follow DOE's recommendation, and to notify both Congress and DOE if the Administrator disagrees with DOE's waiver recommendation and to deliver such notification 10 days prior to issuing a decision . 5. What are the relevant sections in the statute that address small refinery exemption under the RFS? There are three sections in the statute most relevant to small refinery exemptions: 42 U.S.C. 7545(o)(1)(K), 42 U.S.C. 7545(o)(3)(C), and 42 U.S.C. 7545(o)(9). 6. What information must be submitted to EPA to petition for a small refinery exemption? EPA reports that a petition for a small refinery exemption must specify the factors that demonstrate a disproportionate economic hardship and must provide a detailed discussion regarding the hardship the refinery would face in producing transportation fuel meeting the requirements of Â§80.1405 and the date the refiner anticipates that compliance with the requirements can reasonably be achieved at the small refinery. EPA reports that to fulfill these requirements, companies would likely submit "company business plans, financial statements, tax filings, communications with potential suppliers or lenders, and other records that demonstrate the petitioner satisfies the underlying substantive requirements to be accorded relief." To qualify for an exemption, a refinery must meet the definition of a small refinery for both the calendar year before and during the year for which an exemption is sought. Submissions are not publicly available. EPA addressed the financial and other information required for 2016 RFS small refinery exemption requests. In its memorandum, EPA reports it considers the findings of the DOE Small Refinery Study and a variety of economic factors when evaluating a petition. EPA reports the economic factors include, but are not limited to, profitability, net income, cash flow and cash balances, gross and net refining margins, ability to pay for small refinery improvement projects, corporate structure, debt and other financial obligations, RIN prices, and the cost of compliance through RIN purchases. 7. Is there a deadline to apply for an exemption? No. A small refinery may submit a petition to the EPA Administrator for a small refinery exemption at any time. 8. Is there a date by which EPA is to act on an application for an exemption? The EPA Administrator is required by statute to act on a petition for a small refinery exemption within 90 days of having received the petition. EPA reports it "will issue a decision within 90 days of receiving complete supporting information for the request from the small refinery." It is unclear what information must be submitted to EPA before the agency considers a petition "complete." There is no deadline as to when or whether EPA must publicly announce its decision. 9. How frequently may a small refiner apply for an exemption? A small refiner must apply separately for an exemption for each compliance year. According to EPA, "[b]eginning with the 2013 compliance year, small refineries may petition EPA annually for an exemption from their RFS obligations." 10. How are the RFS Renewable Volume Obligations (RVOs) calculated? The statute specifies annual renewable fuel volume amounts (in gallons) required for each category in the RFS through 2022. The EPA converts the statutory volumesâor the volumes EPA has finalized using its waiver authorityâinto annual percentage standards to ensure that obligated parties meet the volume amount. Obligated parties use this annual percentage to compute their RVOs. The RVO is the obligated party's total gasoline and diesel sales multiplied by the annual renewable fuel percentage standards announced by EPA plus any deficit of renewable fuel from the previous year. It is the RVO that informs an obligated party how many gallons of the particular renewable fuel type the party must account for in order to be in compliance. The obligated party is then responsible for submitting to EPA credits (i.e., renewable identification numbers or RINs) for each gallon in its RVO. Once all obligated parties have demonstrated compliance by meeting their RVOs, the volume of renewable fuel required to be blended into the nation's transportation fuel supply is met, minus any SREs. The statute contains volume amounts for four fuel categories: total renewable fuel, advanced biofuel, cellulosic biofuel, and biomass-based diesel. Thus, there are four annual percentage standards, one for each renewable fuel category. Accordingly, there are also four RVO calculations. There are six steps to understanding the relationship between an annual standard, an RVO, and RFS compliance: 1. The statute specifies a volume amount for a given year (e.g., 30 billion gallons for total renewable fuel for 2020); 2. EPA announces the final volume requirement which is either (a) the statutory volume amount or (b) a reduced volume requirement based on EPA's waiver authority (e.g., 20.09 billion gallons for total renewable fuel for 2020); 3. EPA issues an annual percentage standard (e.g., 11.56% for total renewable fuel for 2020); 4. The obligated party multiplies the annual percentage standard by its operational sales to compute its RVO for a particular fuel category; 5. The obligated party obtains the RINs needed to meet its RVO; and 6. The obligated party submits its RINs to EPA to demonstrate compliance. Obligated partiesâgenerally, refiners and importersâmust prove compliance with the RFS each year. Obligated parties include small refineries. However, if a small refinery receives a small refinery exemption, it is exempt from complying with the mandate for a given year. EPA reports "[t]he exempted refinery is not subject to the requirements of an obligated party for fuel produced during the compliance year for which the exemption has been granted." The small refineries that receive a small refinery exemption continue their operations, which may include blending renewable fuel and possibly acquiring RINs (which they can bank for future use or trade with other parties). 11. How do small refinery exemptions impact annual RFS requirements (or RVOs)? The impact of small refinery exemptions on annual RFS requirements, or RVOs, depends on how much fuel is exempted and when. In general, if a small refinery exemption is granted prior to a final rule setting the annual percentage standards being released, it may be accounted for in the annual percentage standard calculation for that year. If the exemption is granted after the final rule has been released, EPA reports that, under its prior approach, it did not revise its annual percentage standard calculation to account for the later-granted exemptions. The situation where the exemption is not included in the annual percentage calculation is of concern to some stakeholders (e.g., renewable fuel producers) as the renewable fuel volumes for which the small refineries were responsible for are not redistributed to the other obligated parties, and therefore those volumes are not accounted for by the RVOs. For example, in December 2017, EPA set the 2018 total renewable fuel percentage standard at 10.67%. EPA did not include any small refinery exemptions in its percentage standard calculations for 2018. Further, EPA stated that any exemptions granted after 2018 would not be reflected in the 2018 percentage standards. In August 2019, EPA announced 31 small refinery exemptions for 2018. EPA estimates that the 31 exemptions will account for nearly 13.4 billion gallons of gasoline and diesel being exempted for the 2018 compliance period. If EPA were to account for the exempted 13.4 billion gallons, it would lead to a different annual percentage standard than the standard contained in the final rule. The non-exempt obligated parties would be required to meet this different standard. Some refer to this as "reallocating the waived gallons." However, as EPA has implemented the program for 2018, the remaining obligated parties will not have to meet this different standard. 12. How many small refinery exemptions have been issued? Since 2013, the number of small refinery exemptions issued based on disproportionate economic hardship has varied, ranging from 7 to 31 in a given year ( Figure 3 ). EPA reports it has not yet received any SRE petitions for 2020. 13. Does the statute require EPA to account for small refinery exemptions in annual standards? The statute requires that EPA adjust the annual percentage standard to "account for the use of renewable fuel during the previous calendar year by small refineries that are exempt under paragraph (9) [Small refineries]." In 2010, EPA reported that it considers the amount of renewable fuel used in such instance would be negligible and assigns it a value of zero. CAA section 211(o) requires that the small refinery adjustment also account for renewable fuels used during the prior year by small refineries that are exempt and do not participate in the RFS2 program. Accounting for this volume of renewable fuel would reduce the total volume of renewable fuel use required of others, and thus directionally would reduce the percentage standards. However, as we discussed in RFS1, the amount of renewable fuel that would qualify, i.e., that was used by exempt small refineries and small refiners but not used as part of the RFS program, is expected to be very small. In fact, these volumes would not significantly change the resulting percentage standards. Whatever renewable fuels small refineries and small refiners blend will be reflected as RINs available in the market; thus there is no need for a separate accounting of their renewable fuel use in the equations used to determine the standards. We proposed and are finalizing this value as zero. In 2018, EPA stated that, regarding Clean Air Act direction that the agency account for renewable fuel used by exempt small refineries, EPA complies through the RIN trading program. In 2019, EPA further explained that the use of renewable fuel by exempt small refineries is accounted for by the RIN system. That is, since exempt small refineries have no obligation to comply with the applicable percentage standards, they can sell all the RINs associated with any renewable fuel they use. These RINs become part of the overall pool of RINs available to all obligated parties. Thus, no additional adjustment needs to be made to comply with this statutory provision. Some stakeholders argue that the amounts exempted in recent years are not negligible, and that reallocating these exempted volumes (as opposed to accounting for them through the RIN trading program) would lead to total renewable fuel consumption closer to the amount finalized by EPA for that year. Others contend that reallocating small refinery exemptions "punishes complying parties and creates an unlevel playing field among competing refineries putting additional pressure on the blendwall and increasing the overall cost of the program." 14. How does EPA account for small refinery exemptions in the 2020 annual standards? In recent years, the number of SREs granted and the total exempted volume of gasoline and diesel has changed, which could indicate the old methodology may no longer suffice. In December 2019, EPA issued a final rule that changes how it calculates the annual percentage standard to account for volumes of gasoline and diesel that will be exempted from the renewable volume obligations. In this final rule, EPA adopted the percentage standard calculation change it proposed in October 2019. In the final rule, EPA reports it is finalizing "a projection methodology based on a 2016â18 annual average of exempted volumes had EPA strictly followed DOE recommendations in those years.â¦" EPA is to do this by amending two factors in the annual percentage standard calculation from: 1. GE i = the amount of gasoline projected to be produced by exempt small refineries and small refiners, in year i and 2. DE i = the amount of diesel fuel projected to be produced by exempt small refineries and small refiners in year i. to 1. GE i = the total amount of gasoline projected to be exempt in year i, in gallons, per Â§Â§80.1441 and 80.1442 and 2. DE i = the total amount of diesel projected to be exempt in year i, in gallons, per Â§Â§80.1441 and 80.1442. EPA reports this calculation modification leads to higher percentage standards, which "would have the effect of ensuring that the required volumes of renewable fuel are met when small refineries are granted exemptions from their 2020 obligations after the issuance of the final rule, provided EPA's projection of the exempted volume is accurate." Further, EPA reports that "[b]y projecting exempted volumes in advance of issuing annual standards, we can issue a single set of standards for each year without the need for periodic revisions and the associated uncertainty for obligated parties." Lastly, EPA reports thatâfor petitions for 2019 and going forwardâit "intends to grant relief consistent with DOE's recommendations where appropriate" (e.g., grant 50% relief where DOE recommends 50% relief). In the past, EPA has granted full exemptions to small refinery petitions where DOE recommended 50% relief. 15. Have there been any legal challenges involving small refinery exemptions?81 Yes. The legal challenges have generally taken one of two forms: (1) refineries challenging the EPA's denial of an exemption petition or (2) parties challenging EPA's methodology for granting and accounting for small refinery exemptions. As discussed below, individual challenges to EPA's exemption denials have at times succeeded, but courts have generally dismissed methodological challenges on procedural grounds. Challenges to Small Refinery Exemption Decisions Several individual refineries have challenged EPA's denials of their exemption petitions. For example, in December 2019 Suncor Energy petitioned for review of its denied exemption petition with the U.S. Court of Appeals for the Tenth Circuit. Refineries have specifically challenged EPA's adoption of DOE's scoring index (as noted in question 4), its reliance on DOE's refinery-specific assessments, and EPA's independent analysis. DOE's scoring matrix assesses whether a small refinery would incur a "disproportionate economic hardship" from complying with the RFS standard using two sets of components: disproportionate impacts metrics and viability metrics. Challenges to exemption denials have generally focused on the viability metrics. In general, courts have upheld as reasonable EPA's adoption of the DOE's scoring matrix, including its use of viability as a metric. The D.C. and the Eighth Circuits have each held that EPA reasonably interpreted the statutory phrase "disproportionate economic hardship" to require, as reflected in DOE's scoring matrix, that the refinery's viability be affected to demonstrate "hardship." However, the Tenth Circuit subsequently held that EPA cannot give such weight to viability, and particularly to the long-term threat of closure, that it effectively reads "disproportionate" out of "disproportionate economic hardship" in the statute. Courts have allowed EPA to rely on DOE's assessments but invalidated exemption denials for errors in the refinery-specific analyses. For example, the D.C. Circuit vacated and remanded an exemption denial because EPA's independent analysis contained two miscalculations that could have affected its ultimate decision to deny the exemption petition. Similarly, the Fourth Circuit vacated and remanded an exemption denial after finding that EPA had relied on a DOE assessment that was facially deficient. The court held that while EPA could rely on DOE's assessment and need not conduct its own independent analysis of DOE's conclusions concerning a specific exemption request, EPA cannot "blindly adopt [those] conclusions" or rely on a report that is "facially-flawed." Several biofuels associations challenged EPA's decision to grant three small refinery exemption petitions on a number of grounds. The Tenth Circuit vacated EPA's decisions for three reasons. First, the court interpreted the phrase " extension of the exemption," found in the statutory language authorizing small refinery exemption petitions, to require that the small refinery have received the exemption each year to be eligible. Second, the court concluded that EPA erred in its analysis by considering sources of economic hardship other than those associated with RFS compliance. The court held that the statute only allowed the exemption to be granted on the basis of disproportionate economic hardship from RFS compliance, not other economic factors such as a downturn in industry profit margins. Finally, the court held that when evaluating whether a small refinery incurs disproportionate economic hardship from RFS complianceâspecifically from having to purchase RINsâEPA must take into account its position that refineries are able to pass the cost of RINs on to consumers in the fuel's price. The court acknowledged that EPA could either depart from this position, which it has previously taken, with an adequate explanation or could explain why the theory did not apply to the small refinery at issue in the petition. But the court held that failing to address the theory at all or how it affected EPA's analysis was arbitrary and capricious. Challenges to EPA's Methodology Parties have raised multiple challenges to how EPA administers the small refinery exemptions. To date, each of these challenges has been dismissed or transferred to another court on procedural grounds without reaching the merits of the parties' arguments. First, in 2018 the Producers of Renewables United for Integrity Truth and Transparency (PRUITT) challenged in the D.C. Circuit how EPA remedied small refinery exemptions it granted on remand after the relevant compliance year had ended. Specifically, PRUITT challenged EPA's decision to issue 2018 RINs to two Wyoming refineries whose 2014 and 2015 exemption petitions were granted after a court vacated and remanded EPA's initial denials in 2017. EPA issued the 2018 RINs to compensate for the 2014 and 2015 RINs that the refineries had retired for compliance before the exemptions were granted. EPA issued 2018 RINs because the 2014 and 2015 RINs the refineries used for compliance had since expired. The D.C. Circuit transferred this portion of the petition to the Tenth Circuit because EPA's issuance of the 2018 replacement RINs to the Wyoming refineries was regionally rather than nationally applicable. Litigation is ongoing. PRUITT also challenged EPA's interpretation of the statutory provision that small refineries "may at any time petition [EPA] for an extension of the exemption." The agency had interpreted that provision to allow it to grant exemptions after it sets the annual standards. The petitioner alleged that EPA violated its statutory duty to ensure the required volumes of renewable fuels are met by granting "retroactive" exemptions. The court dismissed this claim for lack of jurisdiction and, accordingly, did not reach the merits of this argument. Rather than challenging EPA's ability to grant exemptions after it sets the annual standards, the National Biodiesel Board (NBB) challenged how EPA accounts for these exemptions as part of the 2018 rulemaking setting the annual standards. EPA adjusts the annual standards for any exemptions granted before the standards are set, which by statute must occur by November 30 th the prior year. But EPA does not account for those exemptions granted later, either by adjusting the standards retroactively or by accounting for them prospectively using projections. NBB alleged that this approach violates the statute because it does not "ensure" that the volumes are met. The petitioner argued that EPA should project small refinery exemptions EPA was "reasonably likely to grant" after the standards are set, adjust the percentages accordingly, and then adjust for any deficiencies in EPA's projections by incorporating the shortfall into the following year's annual standards. The D.C. Circuit held that NBB had not preserved this challenge to the 2018 rule because it had failed to raise the argument with "reasonable specificity" during the public comment period, as the Clean Air Act requires. Although other parties had submitted comments regarding how EPA accounts for small refinery exemption volumes, the court determined that those comments either requested that EPA "cease granting retroactive exemptions" or "adjust the applicable volumes for the same year in which the retroactive exemptions are later granted." The court concluded that these comments were sufficiently different from NBB's argument that EPA had not had an opportunity to address the argument in its final rule. Accordingly, the D.C. Circuit held that NBB had forfeited the issue. Finally, based on media reports that EPA was increasing the number of exemptions granted, the American Biofuels Association challenged EPA's "decision to modify the criteria or lower the threshold by which [it] determines whether to grant small refineries an exemption." The number of filed and granted exemptions was not public when the lawsuit was filed. EPA subsequently created a small refinery exemption "dashboard" on its website and, in August 2019, issued a formal memorandum documenting its revised standards for granting small refinery exemptions. In the memorandum, EPA explains that it now only requires small refineries to experience either the disproportionate impacts or viability impairment to qualify for the exemption, whereas previously it required small refineries to demonstrate both criteria. In addition, EPA announced that it would grant full waivers when the Department of Energy recommended partial waivers, on the basis that this approach was more consistent with congressional intent. The D.C. Circuit dismissed American Biofuels Association's petition for lack of jurisdiction because the petition was based on a general pattern in agency decisionmaking rather than challenging a particular final agency action as required by the Administrative Procedure Act. The court noted, however, that EPA had acknowledged in oral argument that the August 2019 Memorandum is a final agency action that could be challenged if timely filed. 16. What legislative proposals has Congress introduced that address small refinery exemptions? Some members in the 116 th Congress have introduced bills that address small refinery exemptions. Table 1 provides a summary of each bill. 17. What other issues might one consider when discussing small refinery exemptions? The statute gives the EPA Administrator the authority to grant small refinery exemptions, if a small refinery can prove that compliance would subject it to disproportionate economic hardship. Some Members of Congress contend this authority is being applied improperly and could harm rural economies (e.g., biofuel producers). Others contend that the use of the authority protects small refineries and employment in the oil industry. Below are items Congress may consider as it debates EPA's authority to issue small refinery exemptions. Transparency. Information about certain parts of the small refinery exemption process is limited. For example, it is unclear who is applying for an exemption, what specific information is included in an SRE application, or how an application is evaluated. Further, it is not clear if the same criteria to evaluate an application are used consistently year-to-year. Lastly, EPA does not regularly announce when it has issued an SRE. The statute does not require EPA to share such information publicly. EPA considers an SRE application to contain confidential business information as it includes proprietary information which if disclosed could cause harm to the applicant. EPA states that it "treats both the names of individual petitioners and EPA's decisions on those individual petitions as Confidential Business Information (CBI) under FOIA Exemption 4 (5 U.S.C. Â§Â 522(b)(4)) pending a final CBI determination by the Office of General Counsel." With such transparency issues, it could be difficult for Congress to conduct oversight of EPA's authority to grant small refinery exemptions. Application and decision timeline. Small refinery exemptions are not applied for or granted on a schedule. A small refinery may petition the EPA for an exemption at any time. In theory, once an exemption is issued for a certain year, the small refinery is no longer obligated to meet its RVO for that year. In actuality, the small refinery may not be able to receive the benefit of the exemption for the year it was granted (e.g., if an SRE is granted after the end of a compliance period and the small refinery has already complied with its obligation). Instead, in some cases the small refinery has been credited the RINs it retired to demonstrate compliance with the year that was exempted, and it may use those RINs in a future year. Also, it is not clear what information must be submitted to EPA for the agency to consider a petition "complete"âwhich would start the 90-day timeline for EPA to make a decision. The current application and decision timeline for small refinery exemptions may contribute to an ultimate annual volume requirement that may not match what was announced in a final rule. Inclusion of SREs in annual standards. The statute requires the EPA Administrator to adjust the percentage standards (i.e., annual volume amounts) for a given year by accounting for renewable fuel from the previous calendar year by small refineries that received an exemption. EPA accounts for volumes attributable to exempt small refineries in its formula for calculating the annual percentage standards. EPA complies with this provision through the RIN trading program. Because SRE petitions can be submitted at any time, EPA has two time periods during which it may address SREs in annual standard calculations: prior to a final rule being issued and after a final rule has been issued. EPA reports in its annual rulemaking if it has approved any SREs prior to issuing a final rule and adjusted its calculation accordingly. For instance, in the 2019 final rule, EPA states: at this time no exemptions have been approved for 2019, and therefore we have calculated the percentage standards for 2019 without any adjustment for exempted volumes. We are maintaining our approach that any exemptions for 2019 that are granted after the final rule is released will not be reflected in the percentage standards that apply to all gasoline and diesel produced or imported in 2019. Since 2011 it has been EPA's policy to not account for the SREs that it issues following the release of a final rule. EPA justifies its position based on the November 30 th statutory deadline for setting annual percentage standards and the need to provide the regulated community with certainty and advance notice of the standards. Based on a review of the RFS final rules from 2014 to the present, most or all SREs have been granted after the November 30 th deadline. In 2019, EPA changed how it calculates the annual percentage standard in order to account for volumes of gasoline and diesel that will be exempted from the renewable volume obligations (see question 14). This may be an issue for Congress if Congress intended small refinery exemptions to be accounted for prior to the release of a final rule. Agency discretion. The statute gives the EPA Administrator certain discretion to evaluate an SRE petition. Data provided by EPA in its small refinery exemption dashboard ( Figure 3 ) suggests the Trump Administration has received more SRE petitions and approved more SREs than the Obama Administration on an annual basis. The extent to which discretion should be a factor in the granting of small refinery exemptions may be an issue for Congress. RFS reset. The statute requires that the EPA Administrator modify the applicable volumes of the RFS in future years starting in 2016 if certain conditions are met (the aforementioned RFS "reset"). According to the Office of Management and Budget (OMB), this "reset" has been triggered for total renewable fuel, advanced biofuel, and cellulosic biofuel. It is unclear when or how EPA will carry out such a reset. Congress may consider the impact a reset would have on many parts of the RFS, including small refinery exemptions. U.S. gasoline consumption. The RFS is a volume mandate, not a percentage mandate. The statutory renewable fuel volumes required to be blended are not tied to U.S. gasoline consumption rates. A general guideline is that most passenger vehicles in the U.S. are equipped to handle E10 (a fuel mixture comprised of 10% ethanol and 90% gasoline). Some might interpret this passenger vehicle acceptance rate as indicating that renewable fuel production should be about 10% of the conventional fuel market. Others might interpret this as an opportunity to push for more renewable fuel use (e.g., E15 year-round, flex-fuel vehicles). In any case, this means the statutory volumes could call for renewable fuel volume amounts that are out of alignment with actual gasoline consumption. It also means that EPA has the authorityâwhich it has used multiple timesâto reduce the RFS statutory volume amounts to more closely match actual conditions. Gasoline consumption has trended downwards for years for a variety of reasons (e.g., fuel economy standards, behavioral choices, economic conditions) and is currently steady, while the statutory renewable fuel portion trends upwards. In short, if the RFS cannot in real-time respond to gasoline consumption changes, it could be argued that the RFS renewable fuel targets become more difficult for some to achieve. If the targets are more difficult to achieve, RFS compliance may become a concern for some (e.g., an increase in compliance costs). This compliance burden may lead to more small refineries requesting an exemption. This may be an issue for Congress, if Congress wants market conditions, not projections, to play a role in renewable fuel use.