The Federal Reserve Board (“FRB”) released on June 5, 2013 an interim final rule (“Interim Final Rule”) clarifying that uninsured U.S. branches and agencies of foreign banks will be treated as insured depository institutions for purposes of Section 716 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, referred to herein as the “Swaps Pushout Rule.”1 This means that uninsured U.S. branches and agencies of foreign banks subject to the Swaps Pushout Rule are eligible for the exemptions, transition period to conform activities and grandfathering provisions granted to insured depository institutions under the rule. In practical terms, uninsured U.S. branches and agencies of foreign banks may continue swap activities2 that are limited to (1) hedging and other similar risk-mitigating activities directly related to their activities and (2) acting as a swaps entity for swaps or security-based swaps involving rates or bank-permissible reference assets other than non-cleared credit default swaps. The Interim Final Rule also includes a process by which state member banks and uninsured state branches and agencies of foreign banks may apply to the FRB for a transition period.
The Interim Final Rule became effective on June 5, 2013, and comments must be submitted by August 4, 2013. The FRB may revise the Interim Final Rule in light of the comments received.
The Swaps Pushout Rule generally prohibits the provision of “Federal assistance” to any swaps entity, including any swap dealer, security-based swap dealer, major swap participant and major security-based swap participant registered with the Securities and Exchange Commission (“SEC”) or Commodity Futures Trading Commission (“CFTC”). “Federal assistance” includes advances from any Federal Reserve credit facility or discount window that is not part of a program or facility with broad-based eligibility and Federal Deposit Insurance Corporation (“FDIC”) deposit insurance or guarantees. Before the Swaps Pushout Rule becomes effective on July 16, 2013, certain banks that engage in swap activities and receive Federal assistance (including U.S. branches and agencies of foreign banks) would be required to either “push out” their swap activities to an affiliate or cease such activities, unless an exemption and/or transition period applies.
The Swaps Pushout Rule provides “insured depository institutions,” a term that is not defined in the rule, with certain exemptions from the prohibition, an opportunity to request a transition period to facilitate compliance, and a grandfathering provision for swap activities affected by the rule. However, in what appeared to be a legislative oversight, the rule did not specify whether these provisions benefitting insured depository institutions are extended to foreign banks with uninsured U.S. branches or agencies, many of which have access to the Federal Reserve’s discount window. This resulted in uncertainties regarding how the Swaps Pushout Rule applies to affected foreign banks and whether they receive the same treatment as insured depository institutions. The FRB addresses some of these uncertainties in the Interim Final Rule.
Treatment of Uninsured Branches and Agencies of Foreign Banks as “Insured Depository Institutions”
The Interim Final Rule clarifies that, for purposes of the Swaps Pushout Rule, the term “insured depository institution” includes any insured depository institution as defined in section 3 of the Federal Deposit Insurance Act and any uninsured U.S. branch or agency of a foreign bank. Prior to the Interim Final Rule, there was some ambiguity as to whether an uninsured U.S. branch or agency of a foreign bank is considered an “insured depository institution” since the Swaps Pushout Rule does not provide a definition. The Federal Deposit Insurance Act’s definition of “insured depository institution” includes uninsured U.S. branches and agencies, but only for certain purposes.
In the Interim Final Rule, the FRB determined that uninsured branches and agencies of foreign banks could properly be treated as insured depository institutions for several reasons. Uninsured and insured branches and agencies of foreign banks may receive Federal Reserve advances on the same terms and conditions as domestic insured state member banks, and are therefore treated as insured member banks for purposes of Federal assistance. This approach also furthers the objective of the Swaps Pushout Rule to reduce systemic risks from derivative activities by providing sufficient opportunity for foreign banks’ uninsured branches and agencies to conform or cease their swap activities in an orderly manner and to continue engaging in permissible risk-mitigating hedging and other activities. Finally, former Senator Blanche Lincoln, the sponsor of the Swaps Pushout Rule, and former Senator Christopher Dodd, the Chairman of the Senate Banking Committee, had confirmed on the Senate floor that uninsured U.S. branches and agencies should be treated in the same manner as insured depository institutions.
The FRB’s confirmation that uninsured U.S. branches and agencies are to be treated as insured depository institutions means that these entities can benefit from the Swap Pushout Rule’s exemptions, transition period and grandfathering provisions for insured depository institutions, as described below.
The Swaps Pushout Rule contains an exemption that permits the provision of Federal assistance to insured depository institutions that are swap dealers or security-based swap dealers, if their swap activities are limited to: (1) hedging and other similar risk-mitigating activities directly related to the activities of the insured depository institution and (2) acting as a swaps entity for swaps or security-based swaps involving rates or reference assets permissible for investment by a national bank, other than non-cleared credit default swaps. In addition, the Swaps Pushout Rule provides an exemption for insured depository institutions that are major swap participants or major security-based swap participants (and are not otherwise swap dealers or security-based swap dealers) by excluding them from the definition of “swaps entity.”
Transition Period and Grandfathering
Insured depository institutions that qualify as a swaps entity and are subject to the Federal assistance prohibition can submit a formal request to their appropriate Federal banking agency for a transition period of up to two years to conform their activities to the Swaps Pushout Rule. The transition period may be extended up to one additional year. The Federal banking agency, in consultation with the SEC and CFTC as appropriate, is authorized to establish the length of the transition period and any extension of such period for a particular institution. The Swaps Pushout Rule contains a grandfathering provision whereby prohibitions of the rule apply only to swap activities entered into by an insured depository institution after the expiration of the transition period.
The Interim Final Rule allows state member banks and uninsured state branches and agencies of a foreign bank to make a written request to the FRB for a transition period to conform their activities. They may seek a transition period of up to two years from July 16, 2013 (if they are a swaps entity on that date) or from the date on which they become a swaps entity. The request must include:
- The length of the transition period requested;
- A description of the quantitative and qualitative impact of immediate divestiture or cessation of swap or security-based swap activities on the institution, including the potential impact of divestiture or cessation of swap or security-based swap activities on the institution’s mortgage lending, small business lending, job creation, and capital formation versus the potential negative impact on insured depositors and the Deposit Insurance Fund of the FDIC; and
- A detailed explanation of the institution’s plan for conforming its activities to the requirements of the Swaps Pushout Rule and the FRB’s implementing regulations.
The FRB may require the institution to provide additional information before granting a transition period, and can impose conditions or restrictions on any transition period granted. The transition period can be extended up to one additional year if the insured depository institution submits a request with the information above no later than 60 days before the end of the transition period.
In early January 2013, the Office of the Comptroller of the Currency (the “OCC”) published guidance for insured Federal depository institutions that wish to submit to the OCC a written request for a transition period to comply with the Swaps Pushout Rule (the “OCC Guidance”).3 After the release of the FRB’s Interim Final Rule, on June 12, 2013, the OCC notified uninsured federal U.S. branches and agencies of foreign banks that they may also request a transition period in accordance with the procedures and conditions established in the OCC Guidance.4
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If you have any questions regarding this update, please contact Connie M. Friesen at or (212) 839-5507 or the Sidley lawyer with whom you usually work.
1 The Interim Final Rule is available at: http://www.gpo.gov/fdsys/pkg/FR-2013-06-10/pdf/2013-13670.pdf.
2 Unless otherwise indicated, references to “swap activities” include swap activities and security-based swap activities.
3 The OCC Guidance is available at: http://www.occ.gov/news-issuances/news-releases/2013/nr-occ-2013-2a.pdf.
4 The OCC notice is available at: http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/706f.html.
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