On May 3, 2016, the Board of Governors of the Federal Reserve System (Board) issued a Notice of Proposed Rulemaking on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations (NOPR). The NOPR would require systemically important banks to require non-bank counterparties to amend qualified financial contracts (QFCs) governing, e.g., derivatives, securities lending and repo transactions, to prevent immediate cancellation of the contracts if the firm enters bankruptcy or a resolution process.
Under the NOPR, systemically important banks would need to make clear that their QFCs are governed by the special resolution regimes established by the Federal Deposit Insurance Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act. The NOPR would also require systemically important banks to ensure that their QFCs restrict the ability of counterparties to terminate the contract, liquidate collateral, or exercise other default rights based on the resolution of an affiliate of the systemically important bank.
The Board believes that the mass termination of QFCs at a systemically important bank poses significant risk to the financial system. As described by Chair Janet Yellen in her opening statement introducing the NOPR, when QFCs “unravel all at once at a failed large banking organization, an orderly resolution of the bank may become far more difficult, sparking asset firesales that may consume many firms.”
Compliance with the NOPR would require the amendment of any QFC entered into with a systemically important bank, or, in the alternative, adherence to the International Swaps and Derivatives Association 2015 Resolution Stay Protocol (ISDA Protocol), which extends, through contractual agreement, the application of the special resolution frameworks to all QFCs entered into by a bank holding company and its subsidiaries and establishes restrictions on cross-default rights. Thus, the NOPR proposes a safe harbor for QFCs that have been amended pursuant to the ISDA Protocol, allowing adherence to the ISDA Protocol as an alternative to contractually implementing the NOPR’s restrictions. If adopted as written, the rule would take effect on the first day of the first calendar quarter that begins at least one year after the issuance of the final rule.
The Board is seeking comments, due on August 5, 2016, including responses to the 30 questions incorporated into the NOPR covering its various aspects, definitions and practical implications.