On September 1, the Board of Governors of the Federal Reserve System adopted a final rule that will affect the rights of counterparties that enter into Qualified Financial Contracts (QFC) (e.g., derivatives, stock loans and repurchase agreements) with banks that have been designated as global systemically important banking organizations (GSIBs). This rule, which was proposed in 2016, would prohibit US GSIBs and their subsidiaries, and the US subsidiaries, branches, and agencies of foreign GSIBs, from entering into a QFC unless the counterparty to the contract has agreed contractually:

  • to abide by the 48-hour stay of QFC termination found in Title II of the Dodd-Frank Act and in the Federal Deposit Insurance Act;
  • to allow transfer of the QFC in the event of a resolution of its counterparty; and
  • to refrain from exercising cross-default termination rights arising from the resolution of an affiliate of its GSIB counterparty.

The first two requirements do not apply to a QFC between a US person and a covered entity that is governed by US law because the applicable bank insolvency regime already covers those points. The rule in its entirety does not apply to QFCs between a covered entity and a central clearing party.

The rule includes an unusual safe harbor that deems a covered entity to be compliant if both it and a counterparty have adhered to an applicable resolution regime protocol sponsored by the International Swaps and Derivatives Association, Inc.

The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation are expected to adopt identical rules in the near future, so that all relevant GSIBs are covered.

There are eight American banks currently subject to the new rule: Bank of America, The Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo. It is estimated that 20 foreign GSIBs with US operations are also covered. The definition of “subsidiary” for the purposes of determining whether an entity is covered by the rule comes from the Bank Holding Company Act and, therefore, picks up more entities than the more common standard of greater than 50 percent ownership. The definition of QFC covers “any securities contract, commodity contract, forward contract, repurchase agreement, swap agreement and any similar agreement that the [FDIC] determines by regulation, resolution or order to be a qualified financial contract.”

The rule is effective between the covered entities starting January 2019 and between covered entities and financial counterparties starting June 2019. The rule becomes generally effective for all other counterparties on January 1, 2020.

The relevant Federal Reserve press release and the text of the rule is available here.