Fed Proposes Limits on Qualified Financial Contracts

The Federal Reserve today proposed a rule that would establish restrictions on qualified financial contracts — such as derivative transactions, repurchase agreements, reverse repurchase agreements, and securities lending and borrowing agreements — of U.S. global systemically important banks and the U.S. operations of foreign G-SIBs. The objective of the proposal, the Fed said, is to facilitate the orderly resolution of a failed institution by limiting the ability of the firm’s QFC counterparties to terminate contracts immediately upon the entry of the covered entity or one of its affiliates into resolution.

The proposal would require G-SIBs’ QFCs to contain contractual provisions that recognize the automatic stay of termination provisions and transfer provisions applied in resolutions under the Dodd-Frank Act and the Federal Deposit Insurance Act. The proposal would also generally require QFCs to prohibit a counterparty to the QFC to exercise default rights based on the entry into resolution of an affiliate of the G-SIB. The rule would require banks to conform QFCs from before the compliance date — the first day of the first quarter at least one year after the final rule takes effect — to the rule’s requirements if the bank or an affiliate enters into a new QFC with the same counterparty or an affiliate of the counterparty after the rule goes into effect.

The proposal would facilitate the implementation of the voluntary agreement organized by the International Swaps and Derivatives Association, which extends through contractual agreement the application of the resolution frameworks in the FDIA and Dodd-Frank to all QFCs entered into by a bank holding company and its subsidiaries, including QFCs entered into by banks outside the United States, and establishes restrictions on cross-default rights. The proposal would extend the ISDA stay protocol requirements beyond its current application to apply to QFCs of G-SIBs with all counterparties.

The OCC is expected to issue a proposed rule soon that would subject national banks and federal thrifts that are G-SIB subsidiaries to requirements substantively identical to those proposed by the Fed. Comments are due by Aug. 5. For additional information, please contact Jason Shafer or Hu Benton.