HEF Finance

Ignorance is Bliss and Fantasy is Expensive in the Cannabis Debt Capital Markets

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The cannabis banking and financial services sector has had unique challenges and evolution, however, it’s important to preface those issues with picture of the current banking environment as a whole. In the ever-shifting landscape of finance, recent developments in the banking sector have brought certain challenges and opportunities to the forefront. A recent Reuters article provided valuable insights into the conservative tilt observed in the banking sector. Despite recent modest improvements, both small and big banks are approving loans at a rate significantly lower than the pre-pandemic era. The article also pointed out a potential lag in the effects of aggressive rate hikes on credit availability, raising concerns about the future of business financing as a whole.

Traditional Challenges in Cannabis Financing

Before delving into the potential impact of cannabis rescheduling, it's important to acknowledge the traditional challenges faced by businesses operating in regulated and so-called "sin" industries. These challenges extend beyond the cannabis sector and encompass businesses dealing in alcohol, firearms, liquor production, and retailing, among others. The common thread among these industries is stringent regulation, which often results in unique financing hurdles.

Businesses operating in these sectors typically encounter difficulties in obtaining financing, and when they do secure funding, they often pay a premium. The reasons behind these challenges are deeply rooted in historical and regulatory factors. Banks and financial institutions are wary of associating with industries perceived as higher risk due to potential legal and reputational issues.

Cannabis Rescheduling: A Glimpse into the Future

Now, let's consider the potential impact of cannabis rescheduling from a Schedule I to a Schedule III drug. Such a move would indeed mark a significant shift in the financial services landscape for the cannabis industry. Currently, under the stringent guidelines set by the Financial Crimes Enforcement Network (FinCEN), banks face limitations in providing financial services to cannabis-related businesses, even if they operate legally under state law.

Rescheduling cannabis to Schedule III would imply a recognition of its lower potential for abuse and some currently accepted medical use. This change could lead to an adjustment in FinCEN guidelines, potentially allowing banks to offer financial services to cannabis businesses without violating federal law. However, it's important to note that the traditional issues surrounding anti-money laundering (AML) guidelines may not change significantly. This could result in the continued costliness of banking cannabis accounts, given the sector's historical challenges with money laundering.

Potential Impact on the Cannabis Industry

The rescheduling of cannabis, if it were to occur, would undoubtedly have a positive impact on the cannabis industry. It would likely open doors for businesses to access more traditional banking services, including loans, credit cards, and merchant accounts. This shift could facilitate smoother operations, reduce the risks associated with cash-only transactions, and foster growth within the industry. However, FinCen guidelines would have to dramatically change which currently exist to allow banks to provide banking services at the federal level. Moreover, the idea that cannabis businesses would get preferential treatment over other perceived “sin” businesses that have been legal for a hundred years or more like alcohol, tobacco, and fire arms is a fanciful notion. All of those industries and other highly regulated sectors have continued to be restricted in their borrowing options and pay a premium of cost. Would cannabis be spared from this historical credit disposition? Not likely.

Timeline and Conclusion

While the potential rescheduling of cannabis is a topic of interest, the timeline for such a change remains uncertain. It would require an act of Congress, and even if legislation were to pass, it could take months or even years for FinCEN to update its guidelines.

In conclusion, it's crucial to recognize that the challenges associated with financing in regulated industries, including cannabis, go beyond the scheduling of the substance. It’s crucial because of opportunity cost. Even if cannabis were to be rescheduled to a Schedule III drug or removed from schedule entirely, the financial services landscape would still require monumental changes. Over a century of regulatory culture and banking practices for perceived "sin" businesses will not disappear overnight. The idea of mainstream financing becoming readily available to the cannabis industry is, at best, a complex and long-term endeavor. Businesses operating in these sectors should remain vigilant and adaptable as they navigate the unique challenges of their industries.

If cannabis operators are biding their time expecting impending legislation prior to using current options available to them at a premium in the capital markets, that fantasy will be expensive in terms of opportunity cost. Most cannabis operators understand that the race for increased market share is still in full swing. Debt service is almost always cheaper than shelving lucrative growth opportunities – even with the cannabis premium. Those who wait will for something that is not likely to happen any time soon, if ever, will pay the high price that fantasy commands.

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