On December 16, 2014, President Obama signed the Consolidated and Further Continuing Appropriations Act, 2015 (the “Act”)1 into law. The Act effects two significant amendments to the “swaps push-out” provision enacted as Section 716 of the DoddFrank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”).2 These amendments codify the eligibility of U.S. branches and agencies of foreign banks for the exception to the Federal assistance prohibition available only to “insured depository institutions” (“IDIs”) under the original provision.3
The amendments additionally limit the push-out requirement for qualifying “covered depository institutions” to certain “structured finance swaps” that are not entered into for hedging or risk management purposes.
Section 716 generally prohibits the provision of “Federal assistance,” including advances from the Federal Reserve discount window and insurance or guarantees from the Federal Deposit Insurance Corporation (“FDIC”), to any “swaps entity”4 with regard to any swap, security-based swap5 or other activity of the swaps entity. As originally enacted in Dodd-Frank, Section 716(d) provided that this prohibition would not apply to an IDI that limits its swaps activities, as described below.
Although the Act did not repeal Section 716, its amendments will permit both IDIs and the uninsured U.S. branches and agencies of foreign banks to continue to engage in a broader scope of swaps activities than was originally permitted.6 To the extent such institutions have not yet implemented plans to “push out” nonconforming swaps activities, the Act could significantly reduce the dislocations, costs and client inconvenience associated with Section 716 compliance. The Act will also significantly ameliorate the discrepancy in the scope of swaps that foreign banks are able, through their head offices, to offer clients, on the one hand, and the scope of swaps that U.S. banks (and their foreign branches) were permitted to offer their clients under Section 716, as originally enacted, on the other hand.
The amendments also raise new questions about the scope of permitted swaps activities by covered depository institutions that will need to be answered through future rules or guidance jointly adopted by the prudential regulators.7
The Act made two key changes to Section 716:
First, the Act expands the scope of entities that benefit from the original IDI swaps entity carve-out and the IDI exemption in Section 716(d) to include all “covered depository institutions,” which are defined to include both IDIs as well as uninsured U.S. branches and agencies of foreign banks. This change remedies a widely acknowledged drafting error in Section 716 that could have been read to exclude foreign banks’ uninsured U.S. branches and agencies from the relief provided to IDIs.
Second, the Act significantly broadens the scope of permitted swaps activity under Section 716 for a covered depository institution, although it may potentially narrow the scope of permitted structured finance swap activity.
Under Section 716(d) as originally enacted, IDIs were permitted to transact in (1) swaps for hedging and risk mitigation purposes and (2) otherwise, where limited to swaps on rates or reference assets permitted for investment by a national bank, including swaps on foreign currencies, interest rates, precious metals, government securities and investment grade debt securities (including certain asset-backed securities), but excluding uncleared credit default swaps. Thus, very generally, the major swap asset categories that IDIs were required to push out included commodity swaps, equity and sub-investment grade debt swaps and uncleared credit default swaps, unless entered into for hedging or risk mitigation purposes.
As amended, Section 716(d) now exempts a covered depository institution from the Federal assistance prohibition if it limits its swap activities to the following:
- Hedging and other similar risk mitigating activities directly related to the activities of the covered depository institution;
- Acting as a swaps entity for swaps other than a structured finance swap;8 or
- Acting as a swaps entity for swaps that are structured finance swaps, if such structured finance swaps are either (1) undertaken for hedging or risk management purposes or (2) each asset-backed security underlying such structured finance swaps meets credit quality and classification requirements to be set forth by prudential regulators in future regulations.
In essence, covered depository institutions must push out swaps on assetbacked securities, unless (1) the swap is for hedging or similar risk mitigation or (2) each of the underlying asset-backed securities satisfies credit or other criteria to be identified jointly by the prudential regulators. All other swaps are permitted.
The Act thus significantly broadens the scope of permitted activity under Section 716(d), but may narrow the scope of permitted swaps on asset-backed securities. Specifically, swaps based on certain investment grade asset-backed securities that would have been permitted under the original text of Section 716(d) now must be specifically authorized under regulations to be issued by the prudential regulators. In that regard, the Act does not provide any guidance to the prudential regulators or the industry regarding the credit quality and types of structured finance swaps that should be permitted in eventual regulatory standards, leaving the ultimate scope of swaps that will be required to be pushed out subject to continued uncertainty.
Finally, the Act did not amend the effective date of Section 716 or the provisions governing transition relief. A number of banks have already requested and received a 24-month extension of the transition period under Section 716, postponing the eventual compliance date to July 16, 2015.9 Although the Act’s amendments to Section 716 have significantly eased their compliance burden with respect to a broad range of swaps activity, the continued ambiguities regarding the scope of Section 716 may lead some institutions to seek additional transition relief under Section 716, as amended.