[Federal Register Volume 82, Number 175 (Tuesday, September 12, 2017)]
[Rules and Regulations]
[Pages 42882-42926]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-19053]
[[Page 42881]]
Vol. 82
Tuesday,
No. 175
September 12, 2017
Part II
Federal Reserve System
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12 CFR Parts 217, 249, and 252
Restrictions on Qualified Financial Contracts of Systemically Important
U.S. Banking Organizations and the U.S. Operations of Systemically
Important Foreign Banking Organizations; Revisions to the Definition of
Qualifying Master Netting Agreement and Related Definitions; Final Rule
Federal Register / Vol. 82 , No. 175 / Tuesday, September 12, 2017 /
Rules and Regulations
[[Page 42882]]
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FEDERAL RESERVE SYSTEM
12 CFR Parts 217, 249, and 252
[Regulations Q, WW, and YY; Docket No. R-1538]
RIN 7100-AE52
Restrictions on Qualified Financial Contracts of Systemically
Important U.S. Banking Organizations and the U.S. Operations of
Systemically Important Foreign Banking Organizations; Revisions to the
Definition of Qualifying Master Netting Agreement and Related
Definitions
AGENCY: Board of Governors of the Federal Reserve System (Board),
Federal Reserve System.
ACTION: Final rule.
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SUMMARY: The Board is adopting a final rule to promote U.S. financial
stability by improving the resolvability and resilience of systemically
important U.S. banking organizations and systemically important foreign
banking organizations pursuant to section 165 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank Act). Under the
final rule, any U.S. top-tier bank holding company identified by the
Board as a global systemically important banking organization (GSIB),
the subsidiaries of any U.S. GSIB (other than national banks, federal
savings associations, state nonmember banks, and state savings
associations), and the U.S. operations of any foreign GSIB (other than
national banks, federal savings associations, state nonmember banks,
and state savings associations) would be subjected to restrictions
regarding the terms of their non-cleared qualified financial contracts
(QFCs). First, a covered entity generally is required to ensure that
QFCs to which it is party provide that any default rights and
restrictions on the transfer of the QFCs are limited to the same extent
as they would be under the Dodd-Frank Act and the Federal Deposit
Insurance Act. Second, a covered entity generally is prohibited from
being party to QFCs that would allow a QFC counterparty to exercise
default rights against the covered entity, directly or indirectly,
based on the entry into a resolution proceeding under the Dodd-Frank
Act or Federal Deposit Insurance Act, or any other resolution
proceeding, of an affiliate of the covered entity. The final rule also
amends certain definitions in the Board's capital and liquidity rules;
these amendments are intended to ensure that the regulatory capital and
liquidity treatment of QFCs to which a covered entity is party is not
affected by the final rule's restrictions on such QFCs. The Office of
the Comptroller of the Currency (OCC) and the Federal Deposit Insurance
Corporation (FDIC) are expected to issue final rules that would subject
GSIB subsidiaries for which the OCC and FDIC are the appropriate
Federal banking agency to requirements substantively identical to those
in this final rule.
DATES: The final rule is effective on November 13, 2017.
FOR FURTHER INFORMATION CONTACT: Anna Harrington, Senior Supervisory
Financial Analyst (202) 452-6406, or Sean Campbell, Associate Director,
(202) 452-3760, Division of Supervision and Regulation; or Will Giles,
Senior Counsel, (202) 452-3351, or Lucy Chang, Senior Attorney, (202)
475-6331, Legal Division, Board of Governors of the Federal Reserve
System, 20th and C Streets NW., Washington, DC 20551. For the hearing
impaired only, Telecommunications Device for the Deaf (TDD) users may
contact (202) 263-4869.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Background
B. Notice of Proposed Rulemaking and General Summary of Comments
C. Overview of Final Rule
D. Consultation With U.S. Financial Regulators, the Council, and
Foreign Authorities
II. Restrictions on QFCs of GSIBs
A. Covered Entities (Section 252.82(b) of the Final Rule)
B. Covered QFCs (Section 252.82(c) of the Final Rule)
C. Definition of ``Default Right'' (Section 252.81 of the Final
Rule)
D. Required Contractual Provisions Related to the U.S. Special
Resolution Regimes (Section 252.83 of the Final Rule)
E. Prohibited Cross-Default Rights (Section 252.84 of the Final
Rule)
F. Process for Approval of Enhanced Creditor Protections
(Section 252.85 of the Final Rule)
III. Transition Periods
IV. Costs and Benefits
V. Revisions to Certain Definitions in the Board's Capital and
Liquidity Rules
VI. Regulatory Analysis
A. Paperwork Reduction Act
B. Regulatory Flexibility Act: Final Regulatory Flexibility
Analysis
C. Riegle Community Development and Regulatory Improvement Act
of 1994
D. Use of Plain Language
I. Introduction
A. Background
In May 2016, the Board invited comment on a notice of proposed
rulemaking (``proposal'' or ``proposed rule'') to impose restrictions
on the qualified financial contracts (QFCs)--such as derivatives
contracts and repurchase agreements--of U.S. global systemically
important banking organizations (GSIBs) and the U.S. operations of
global systemically important foreign banking organizations or
``foreign GSIBs'' (collectively, ``covered entities'').\1\ The proposal
would have required the QFCs of covered entities to contain contractual
provisions that opt into the temporary stay-and-transfer treatment of
the Federal Deposit Insurance Act (FDI Act) and the Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank Act), thereby
reducing the risk that the stay-and-transfer treatment would be
challenged by a QFC counterparty or a court in a foreign jurisdiction.
The FDI Act and Title II of the Dodd-Frank Act create special
resolution frameworks for failed financial firms that provide that the
rights of a failed firm's counterparties to terminate their QFCs are
temporarily stayed when the firm enters a resolution proceeding to
allow for the transfer of the relevant obligations under the QFC to a
solvent party. The proposal also would have prohibited the exercise of
default rights in QFCs related, directly or indirectly, to the entry
into resolution of an affiliate of a covered entity (cross-default
rights), subject to certain creditor protection exceptions that would
not be expected to interfere with an orderly resolution.
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\1\ 81 FR 29169 (May 11, 2016).
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This final rule, which is part of a set of actions by the Board to
address the ``too-big-to-fail'' problem, addresses one of the ways in
which the severe distress or failure of a major financial firm can
destabilize the U.S. financial system. Protecting the financial
stability of the United States by helping to address this too-big-to-
fail problem is a core objective of the Dodd-Frank Act,\2\ which
Congress passed in response to the 2007-2009 financial crisis and the
ensuing recession. As illustrated by the failure of Lehman Brothers in
September of 2008, the failure of a large, interconnected financial
company could cause severe damage to the U.S. financial system and,
ultimately, to the economy as a whole. The Dodd-Frank Act and the
actions that U.S. financial regulators have taken to implement it and
to otherwise protect U.S. financial stability help to address the too-
big-to-
[[Page 42883]]
fail problem in two ways: By reducing the probability that a
systemically important financial company will fail, and by reducing the
damage that such a company's failure would do if it were to occur. The
second of these strategies, which is supported by this final rule,
centers on measures designed to help ensure that a failed company's
passage through a resolution proceeding--such as bankruptcy or the
special resolution process created by the Dodd-Frank Act--would be more
orderly, thereby helping to mitigate destabilizing effects on the rest
of the financial system.\3\
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\2\ The Dodd-Frank Act was enacted on July 21, 2010 (Pub. L.
111-203). According to its preamble, the Dodd-Frank Act is intended
``[t]o promote the financial stability of the United States by
improving accountability and transparency in the financial system,
to end `too big to fail', [and] to protect the American taxpayer by
ending bailouts.''
\3\ The Dodd-Frank Act itself pursues this goal through numerous
provisions, including by requiring systemically important financial
companies to develop resolution plans (also known as ``living
wills'') that lay out how they could be resolved in an orderly
manner if they were to fail and by creating a new resolution regime,
the Orderly Liquidation Authority, applicable to systemically
important financial companies. 12 U.S.C. 5365(d), 5381-5394.
Moreover, section 165 of the Dodd-Frank Act directs the Board to
promote financial stability through regulation by subjecting large
bank holding companies and nonbank financial companies designated
for Board supervision to enhanced prudential standards ``[i]n order
to prevent or mitigate risks to the financial stability of the
United States that could arise from the material financial distress
or failure, or ongoing activities, of large, interconnected
financial institutions.'' 12 U.S.C. 5365(a)(1).
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This final rule represents a further step to increase the
resolvability and resilience of U.S. GSIBs and foreign GSIBs that
operate in the United States. The final rule complements the Board's
final rulemaking on total loss-absorbing capacity, long-term debt, and
clean holding company requirements for GSIBs (TLAC final rule) \4\ and
the ongoing work of the Board and the Federal Deposit Insurance
Corporation (FDIC) on resolution planning requirements for GSIBs. The
final rule focuses on improving the orderly resolution of a GSIB by
limiting disruptions to a failed GSIB through its financial contracts
with other companies. In particular, the requirements of the final rule
seek to facilitate the orderly resolution of a failed GSIB by limiting
the ability of the firm's QFC counterparties to terminate such
contracts immediately upon entry of the GSIB or one of its affiliates
into resolution. Given the large volume of QFCs to which covered
entities are a party, the exercise of default rights en masse as a
result of the failure or significant distress of a covered entity could
lead to failure and a disorderly resolution if the failed firm were
forced to sell off assets, which could spread contagion by increasing
volatility and lowering the value of similar assets held by other
firms, or to withdraw liquidity that it had provided to other firms.
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\4\ 82 FR 8266 (Jan. 24, 2017).
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The largest financial firms are interconnected with other financial
firms through large volumes of financial contracts of various types,
including derivatives transactions. The severe distress or failure of
one entity within a large financial firm can trigger disruptive
terminations of these contracts, as the counterparties of both the
failed entity and other entities within the same firm exercise their
contractual rights to terminate the contracts and liquidate collateral.
These terminations, especially if counterparties lose confidence in the
GSIB quickly and in large numbers, can destabilize the financial system
and potentially spark a financial crisis through several channels. They
can destabilize the failed entity's otherwise solvent affiliates,
causing them to fail and thereby destabilizing the entire organization,
as well as potentially causing their counterparties to fail in a chain
reaction that can ripple through the system. They also may result in
fire sales of large volumes of financial assets, such as the collateral
that secures the contracts, which can in turn weaken and cause stress
for other firms by lowering the value of similar assets that they hold.
For example, the triggering of default rights by counterparties of
Lehman Brothers (Lehman) in 2008 was a key driver of the
destabilization that resulted from its failure.\5\ At the time of its
failure, Lehman was party to very large volumes of financial contracts,
including over-the-counter derivatives contracts.\6\ When its holding
company declared bankruptcy, Lehman's counterparties exercised their
default rights.\7\ Lehman's default ``caused disruptions in the swaps
and derivatives markets and a rapid, market-wide unwinding of trading
positions.'' \8\ Meanwhile, ``out-of-the-money counterparties, which
owed Lehman money, typically chose not to terminate their contracts''
and instead suspended payment, reducing the liquidity available to the
bankruptcy estate.\9\ The complexity and disruption associated with
Lehman's portfolios of financial contracts led to a disorderly
resolution of Lehman.\10\ This final rule is meant to help avoid a
repeat of the systemic disruptions caused by the Lehman failure by
preventing the exercise of default rights in financial contracts from
leading to such disorderly and destabilizing severe distress or
failures in the future.
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\5\ See ``The Orderly Liquidation of Lehman Brothers Holdings
Inc. under the Dodd-Frank Act'' 3, FDIC Quarterly (2011) (``The
Lehman bankruptcy had an immediate and negative effect on U.S.
financial stability and has proven to be a disorderly, time-
consuming, and expensive process.''), https://www.fdic.gov/bank/analytical/quarterly/2011_vol5_2/lehman.pdf.
\6\ See Michael J. Fleming and Asani Sarkar, ``The Failure
Resolution of Lehman Brothers,'' FRBNY Economic Policy Review 185
(Dec. 2014), https://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412flem.pdf.
\7\ See id.
\8\ ``The Orderly Liquidation of Lehman Brothers Holdings Inc.
under the Dodd-Frank Act'' 3, FDIC Quarterly (2011), https://www.fdic.gov/bank/analytical/quarterly/2011_vol5_2/lehman.pdf.
\9\ Michael J. Fleming and Asani Sarkar, ``The Failure
Resolution of Lehman Brothers,'' FRBNY Economic Policy Review 185
(Dec. 2014), https://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412flem.pdf.
\10\ See Mark J. Roe and Stephen D. Adams, ``Restructuring
Failed Financial Firms in Bankruptcy: Selling Lehman's Derivatives
Portfolio,'' Yale Journal on Regulation (2015) (``Lehman's failure
exacerbated the financial crisis, especially after AIG's collapse in
the days afterwards prompted counterparties to close out positions,
sell collateral, and thereby depress and freeze markets. Many
financial players stopped trading for fear that their counterparty
would be the next Lehman or that their counterparty had large unseen
exposures to Lehman that would make the counterparty itself fail.
Such was the case with the Reserve Primary Fund, a money market fund
that held too many defaulting obligations of Lehman. That reaction
led to a further panic, a threat of a run on money market funds, and
a government guarantee of all money market funds to stem the ongoing
financial degradation throughout the economy.'').
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This final rule responds to the threat to financial stability posed
by such default rights in two ways. First, the final rule reduces the
risk that courts in foreign jurisdictions would disregard statutory
provisions that would stay the rights of a failed firm's counterparties
to terminate their contracts when the firm enters a resolution
proceeding under one of the special resolution frameworks for failed
financial firms created by Congress under the FDI Act and the Dodd-
Frank Act. Second, the final rule facilitates the resolution of a large
financial entity under the U.S. Bankruptcy Code and other resolution
frameworks by ensuring that the counterparties of solvent affiliates of
the failed entity cannot unravel their contracts with the solvent
affiliate based solely on the failed entity's resolution.
The Board is issuing this final rule under section 165 of the Dodd-
Frank Act, as well as its safety and soundness and other relevant
authorities.\11\ Section 165 instructs the Board to impose enhanced
prudential standards on bank holding companies with total consolidated
assets of $50 billion or more ``[i]n order to prevent or mitigate risks
to the financial stability of the
[[Page 42884]]
United States that could arise from the material financial distress or
failure, or ongoing activities, of large, interconnected financial
institutions.'' \12\ These enhanced prudential standards must increase
in stringency based on the systemic footprint and risk characteristics
of covered firms.\13\ Section 165 requires the Board to impose enhanced
prudential standards of several specified types and also authorizes the
Board to establish ``such other prudential standards as the Board of
Governors, on its own or pursuant to a recommendation made by the
Council, determines are appropriate.'' \14\
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\11\ 12 U.S.C. 321-338a, 481-486, 1467a, 1818, 1828, 1831n,
1831o, 1831p-l, 1831w, 1835, 1844(b), 1844(c), 3101 et seq., 3101
note, 3904, 3906-3909, 4808, 5361, 5362, 5365, 5366, 5367, 5368,
5371.
\12\ 12 U.S.C. 5365(a)(1).
\13\ 12 U.S.C. 5365(a)(1)(B), (b)(3)(A)-(D).
\14\ 12 U.S.C. 5365(b)(1)(B)(iv).
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The enhanced prudential standards in this final rule are intended
to prevent or mitigate risks to the financial stability of the United
States that could arise from the material financial distress or failure
of a GSIB. In particular, the final rule's requirements are intended to
improve the resolvability and resilience of U.S. GSIBs under the U.S.
Bankruptcy Code, Title II of the Dodd-Frank Act, or, with reference to
insured depository institutions that are GSIB subsidiaries, the FDI
Act, and reduce the potential that resolution of the firm will be
disorderly and lead to disruptive asset sales and liquidations.
The final rule should also improve the resilience of the U.S.
operations of foreign GSIBs, and thereby increase the likelihood that a
failed foreign GSIB with U.S. operations would be successfully resolved
by its home jurisdiction authorities without the severe distress or
failure of the foreign GSIB's U.S. operating entities and with limited
effect on the financial stability of the United States.\15\
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\15\ As discussed in detail in this SUPPLEMENTARY INFORMATION
section, this rule is intended to help prevent systemic disruptions
that may arise as a result of the exercise of certain contractual
rights contained in QFCs entered into by GSIBs or their
subsidiaries. This rule includes certain limitations on the exercise
of these rights with a view to preventing such systemic disruptions.
Separate from these limitations, both Title II of the Dodd-Frank Act
and the FDI Act include various restrictions on the exercise of
rights by parties to QFCs and provide the FDIC, as receiver of a
company subject to resolution under Title II or the FDI Act, with
special authorities. None of the provisions of this rule should be
construed as being intended to modify or limit, in any manner, the
rights and powers of the FDIC as receiver under Title II or the FDI
Act, including, without limitation, the rights of the FDIC as
receiver to enforce provisions of Title II or the FDI Act that limit
the enforceability of certain contractual provisions.
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The Board has tailored this final rule to apply only to those
banking organizations whose disorderly failure or severe distress would
be likely to pose the greatest risk to U.S. financial stability: The
U.S. GSIBs and the U.S. operations of foreign GSIBs. The Board believes
that limiting the application of this final rule in this way sensibly
balances the costs and benefits of the rule by effectively managing
systemic risk while at the same time limiting the burden of compliance
by not requiring non-GSIB firms with total assets in excess of $50
billion to comply with any part of this final rule.
Qualified financial contracts, default rights, and financial
stability. The final rule pertains to several important classes of
financial transactions that are collectively known as ``qualified
financial contracts.'' \16\ QFCs include derivatives, repurchase
agreements (also known as ``repos''), reverse repos, and securities
lending and borrowing agreements.\17\ GSIBs enter into QFCs for a
variety of purposes, including to borrow money to finance their
investments, to lend money, to manage risk, and to enable their clients
and counterparties to hedge risks, make markets in securities and
derivatives, and take positions in financial investments.
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\16\ The final rule adopts the definition of ``qualified
financial contract'' set out in section 210(c)(8)(D) of the Dodd-
Frank Act, 12 U.S.C. 5390(c)(8)(D). See final rule Sec. 252.81.
\17\ The definition of ``qualified financial contract'' is
broader than this list of examples, and the default rights discussed
are not common to all types of QFC. See final rule Sec. 252.81.
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QFCs play a role in economically valuable financial intermediation
when markets are functioning normally. But they are also a major source
of financial interconnectedness, which can pose a threat to financial
stability in times of market stress. The final rule focuses on a
context in which that threat is especially great: The severe distress
or failure of a GSIB that is party to large volumes of QFCs, which are
likely to include QFCs with counterparties that are themselves
systemically important.
By contract, a party to a QFC generally has the right to take
certain actions if its counterparty defaults on the QFC (that is, if it
fails to meet certain contractual obligations). Common default rights
include the right to suspend performance of the non-defaulting party's
obligations, the right to terminate or accelerate the contract, the
right to set off amounts owed between the parties, and the right to
seize and liquidate the defaulting party's collateral. In general,
default rights allow a party to a QFC to reduce the credit risk
associated with the QFC by granting it the right to exit the QFC and
thereby reduce its exposure to its counterparty upon the occurrence of
a specified condition, such as its counterparty's entry into a
resolution proceeding.
Where the defaulting party is a GSIB entity, the private benefit of
allowing counterparties of GSIBs to take certain actions must be
weighed against the harm that these actions may cause by contributing
to the severe distress or disorderly failure of a GSIB and increasing
the threat to the stability of the U.S. financial system as a whole.
For example, if a significant number of QFC counterparties exercise
their default rights precipitously and in a manner that would impede an
orderly resolution of a GSIB, all QFC counterparties and the financial
system may potentially be worse off and less stable.
This may occur through several channels. First, the exits may drain
liquidity from a troubled GSIB, forcing the GSIB to rapidly sell off
assets at depressed prices, both because the sales must be done within
a short timeframe and because the elevated supply may push prices down.
These asset fire sales may cause or deepen balance-sheet insolvency at
the GSIB, causing a GSIB to fail more suddenly and reducing the amount
that its other creditors can recover, thereby imposing losses on those
creditors and threatening their solvency. The GSIB may also respond to
a QFC run by withdrawing liquidity that it had offered to other firms,
forcing them to engage in fire sales. Alternatively, if the GSIB's QFC
counterparty itself liquidates the QFC collateral at fire sale prices,
the effect will again be to weaken the GSIB's balance sheet as the GSIB
marks those assets down to the new fire sale induced price level.\18\
The counterparty's rights to set-off amounts owed, terminate the
contract, or suspend payments may allow it to further drain the GSIB's
capital and liquidity by withholding payments that it would otherwise
owe to the GSIB. The GSIB may also have rehypothecated collateral that
it received from QFC counterparties, for instance in repo or securities
lending transactions that fund other client arrangements, in which case
demands from those counterparties for the early
[[Page 42885]]
return of their rehypothecated collateral could be especially
disruptive.\19\
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\18\ See ``The Orderly Liquidation of Lehman Brothers Holdings
Inc. under the Dodd-Frank Act'' 8, FDIC Quarterly (2011), https://www.fdic.gov/bank/analytical/quarterly/2011_vol5_2/lehman.pdf (``A
disorderly unwinding of [qualified financial contracts] triggered by
an event of insolvency, as each counterparty races to unwind and
cover unhedged positions, can cause a tremendous loss of value,
especially if lightly traded collateral covering a trade is sold
into an artificially depressed, unstable market. Such disorderly
unwinding can have severe negative consequences for the financial
company, its creditors, its counterparties, and the financial
stability of the United States.'').
\19\ See generally Adam Kirk, James McAndrews, Parinitha Sastry,
and Phillip Weed, ``Matching Collateral Supply and Financing Demands
in Dealer Banks,'' FRBNY Economic Policy Review 127 (Dec. 2014),
http://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412kirk.pdf.
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The asset fire sales discussed above can also spread contagion
throughout the financial system by increasing volatility and by
lowering the value of similar assets held by other firms, potentially
causing these firms to suffer mark-to-market losses, diminished market
confidence in their own solvency, margin calls, and creditor runs
(which could lead to further fire sales, worsening the contagion).
Finally, the early terminations of derivatives upon which the surviving
entities of the failed GSIB relied to hedge their risks could leave
those entities with major risks unhedged, increasing the entities'
potential losses going forward.
Where there are significant simultaneous terminations and these
effects occur contemporaneously, such as upon the failure or severe
distress of a GSIB that is party to a large volume of QFCs, they may
pose a substantial risk to financial stability. In short, QFC
continuity is important for the orderly resolution of a GSIB because it
helps to ensure that the GSIB entities remain viable and to avoid
instability caused by asset fire sales.
Consequently, the Board and the FDIC have identified the exercise
of certain default rights in financial contracts as a potential
obstacle to orderly resolution in the context of resolution plans filed
pursuant to section 165(d) of the Dodd-Frank Act \20\ and have
instructed the most systemically important firms to demonstrate that
they are ``amending, on an industry-wide and firm-specific basis,
financial contracts to provide for a stay of certain early termination
rights of external counterparties triggered by insolvency
proceedings.'' \21\
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\20\ 12 U.S.C. 5365(d).
\21\ Board and FDIC, ``Agencies Provide Feedback on Second Round
Resolution Plans of `First-Wave' Filers'' (Aug. 5, 2014), http://www.federalreserve.gov/newsevents/press/bcreg/20140805a.htm. See
also Board and FDIC, ``Guidance for 2018 Sec. 165(d) Annual
Resolution Plan Submissions By Foreign-based Covered Companies that
Submitted Resolution Plans in July 2015,'' (Mar. 24, 2017), https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20170324a21.pdf; Board and FDIC, ``Guidance for 2017 Sec.
165(d) Annual Resolution Plan Submissions By Domestic Covered
Companies that Submitted Resolution Plans in July 2015,'' (Apr. 13,
2016), https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20160413a1.pdf; Board and FDIC, ``Agencies Provide
Feedback on Resolution Plans of Three Foreign Banking
Organizations,'' (Mar. 23, 2015), http://www.federalreserve.gov/newsevents/press/bcreg/20150323a.htm; Board and FDIC, ``Guidance for
2013 165(d) Annual Resolution Plan Submissions by Domestic Covered
Companies that Submitted Initial Resolution Plans in 2012'' (Apr.
15, 2013), http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20130415c2.pdf.
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Direct defaults and cross-defaults. This final rule focuses on two
distinct scenarios in which a non-defaulting party to a QFC is commonly
able to exercise the rights described above. These two scenarios
involve a default that occurs when either the GSIB legal entity that is
a direct party \22\ to the QFC or an affiliate of that legal entity
enters a resolution proceeding.\23\ The first scenario occurs when a
GSIB entity that is itself a direct party to the QFC enters a
resolution proceeding; this preamble refers to such a scenario as a
``direct default'' and refers to the default rights that arise from a
direct default as ``direct default rights.'' The second scenario occurs
when an affiliate of the GSIB entity that is a direct party to the QFC
(such as the direct party's parent holding company) enters a resolution
proceeding; this preamble refers to such a scenario as a ``cross-
default'' and refers to default rights that arise from a cross-default
as ``cross-default rights.'' For example, a GSIB parent entity might
guarantee the derivatives transactions of its subsidiaries, and those
derivatives contracts could contain cross-default rights against a
subsidiary of the GSIB that would be triggered by the bankruptcy filing
of the GSIB parent entity even though the subsidiary continues to meet
all of its financial obligations.\24\
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\22\ In general, a ``direct party'' refers to a party to a
financial contract other than a credit enhancement (such as a
guarantee). The definition of ``direct party'' and related
definitions are discussed in more detail below.
\23\ This preamble uses phrases such as ``entering a resolution
proceeding'' and ``going into resolution'' to encompass the concept
of ``becoming subject to a receivership, insolvency, liquidation,
resolution, or similar proceeding.'' These phrases refer to
proceedings established by law to deal with a failed legal entity.
In the context of the failure of a systemically important banking
organization, the most relevant types of resolution proceeding
include the following: For most U.S.-based legal entities, the
bankruptcy process established by the U.S. Bankruptcy Code (Title
11, United States Code); for U.S. insured depository institutions, a
receivership administered by the FDIC under the FDI Act (12 U.S.C.
1821); for companies whose ``resolution under otherwise applicable
Federal or State law would have serious adverse effects on the
financial stability of the United States,'' the Dodd-Frank Act's
Orderly Liquidation Authority (12 U.S.C. 5383(b)(2)); and, for
entities based outside the United States, resolution proceedings
created by foreign law.
\24\ See Michael J. Fleming and Asani Sarkar, ``The Failure
Resolution of Lehman Brothers,'' FRBNY Economic Policy Review 185
(Dec. 2014), https://www.newyorkfed.org/medialibrary/media/research/epr/2014/1412flem.pdf.
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Importantly, this final rule does not affect all types of default
rights. Moreover, the final rule is concerned only with default rights
that run against a GSIB--that is, direct default rights and cross-
default rights that arise from the entry into resolution of a GSIB
entity. The final rule does not affect default rights that a GSIB
entity (or any other entity) may have against a counterparty that is
not a GSIB entity. This limited scope is appropriate because, as
described above, the risk posed to financial stability by the exercise
of QFC default rights is greatest when the defaulting counterparty is a
GSIB entity.
Single-point-of-entry resolution. Cross-default rights are
especially significant in the context of a GSIB failure because GSIBs
typically enter into large volumes of QFCs through different entities
controlled by the GSIB. For example, a U.S. GSIB is made up of a U.S.
bank holding company and numerous operating subsidiaries that are
owned, directly or indirectly, by the bank holding company. From the
standpoint of financial stability, the most important of these
operating subsidiaries are generally a U.S. insured depository
institution, a U.S. broker-dealer, and similar entities organized in
other countries.
Many complex GSIBs have developed resolution strategies that rely
on a single-point-of-entry (SPOE) resolution strategy. In an SPOE
resolution of a GSIB, only a single legal entity--the GSIB's top-tier
bank holding company--would enter a resolution proceeding. The losses
that led to the GSIB's failure would be passed up from the operating
subsidiaries that incurred the losses to the holding company and would
then be imposed on the equity holders and unsecured creditors of the
holding company through the resolution process.\25\ This strategy is
designed to help ensure that the GSIB subsidiaries remain adequately
capitalized and that operating subsidiaries of the GSIB are able to
continue to meet their financial obligations without defaulting or
entering resolution themselves. The expectation that the holding
company's equity holders and unsecured creditors would absorb the
GSIB's losses in the event of failure would help to maintain the
confidence of the operating subsidiaries' creditors and counterparties
(including their QFC
[[Page 42886]]
counterparties), reducing their incentive to engage in potentially
destabilizing funding runs or margin calls and thus lowering the risk
of asset fire sales. A successful SPOE resolution would also avoid the
need for separate resolution proceedings for separate legal entities
run by separate authorities across multiple jurisdictions, which would
be more complex and could therefore destabilize the resolution of a
GSIB.
---------------------------------------------------------------------------
\25\ The Board's final rule regarding total loss-absorbing
capacity, long term debt and clean holding company requirements
(TLAC rule) addresses the need for adequate external loss-absorbing
capacity at the holding company level by requiring the top-tier
holding companies of the U.S. GSIBs and the U.S. intermediate
holding companies of foreign GSIBs to maintain outstanding required
levels of unsecured long-term debt and TLAC, which is defined to
include both tier 1 capital and eligible long-term debt. See 82 FR
8266, 8287 (Jan. 24, 2017).
---------------------------------------------------------------------------
The Board's TLAC rule is intended to help, though not exclusively,
to lay the foundation necessary for the SPOE resolution of a GSIB by
requiring the top-tier holding companies of U.S. GSIBs and the U.S.
intermediate holding companies of foreign GSIBs to maintain sufficient
amounts of loss-absorbing capacity that could be used for resolution
and to adopt a ``clean holding company'' structure, under which certain
financial activities that could pose obstacles to orderly resolution
would be impermissible for the holding company and could only be
conducted by its operating subsidiaries.\26\
---------------------------------------------------------------------------
\26\ See 82 FR 8266 (Jan. 24, 2017).
---------------------------------------------------------------------------
Other orderly resolution strategies. This final rule is also
intended to yield benefits for other approaches to resolution. For
example, preventing early terminations of QFCs would increase the
prospects for an orderly resolution under a multiple-point-of-entry
(MPOE) strategy involving a foreign GSIB's U.S. intermediate holding
company going into resolution or a resolution plan that calls for a
GSIB's U.S. insured depository institution to enter resolution under
the FDI Act. As discussed above, the final rule should help support the
continued operation of one or more affiliates of an entity that has
entered resolution to the extent the affiliate continues to perform on
its QFCs.
U.S. Bankruptcy Code. When an entity goes into resolution under the
U.S. Bankruptcy Code, attempts by the debtor entity's creditors to
enforce their debts through any means other than participation in the
bankruptcy proceeding (for instance, by suing in another court, seeking
enforcement of a preexisting judgment, or seizing and liquidating
collateral) are generally blocked by the imposition of an automatic
stay.\27\ A key purpose of the automatic stay, and of bankruptcy law in
general, is to maximize the value of the bankruptcy estate and the
creditors' ultimate recoveries by facilitating an orderly liquidation
or restructuring of the debtor. The automatic stay thus solves a
collective action problem in which the creditors' individual incentives
to become the first to recover as much from the debtor as possible,
before other creditors can do so, collectively cause a value-destroying
disorderly liquidation of the debtor.\28\
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\27\ See 11 U.S.C. 362.
\28\ See, e.g., Aiello v. Providian Financial Corp., 239 F.3d
876, 879 (7th Cir. 2001).
---------------------------------------------------------------------------
However, the U.S. Bankruptcy Code largely exempts QFC \29\
counterparties of the debtor from the automatic stay through special
``safe harbor'' provisions.\30\ Under these provisions, any rights that
a QFC counterparty has to terminate the contract, set-off obligations,
or liquidate collateral in response to a direct default are not subject
to the stay and may be exercised against the debtor immediately upon
default. (The U.S. Bankruptcy Code does not itself confer default
rights upon QFC counterparties; it merely permits QFC counterparties to
exercise certain rights created by other sources, such as contractual
rights created by the terms of the QFC.)
---------------------------------------------------------------------------
\29\ The U.S. Bankruptcy Code does not use the term ``qualified
financial contract,'' but the set of transactions covered by its
safe harbor provisions closely tracks the set of transactions that
fall within the definition of ``qualified financial contract'' used
in Title II of the Dodd-Frank Act and in this final rule.
\30\ 11 U.S.C. 362(b)(6), (7), (17), (27), 362(o), 555, 556,
559, 560, 561. The U.S. Bankruptcy Code specifies the types of
parties to which the safe harbor provisions apply, such as financial
institutions and financial participants. Id.
---------------------------------------------------------------------------
The U.S. Bankruptcy Code's automatic stay also does not prevent the
exercise of cross-default rights against an affiliate of the party
entering resolution. The stay generally applies only to actions taken
against the party entering resolution or the bankruptcy estate,\31\
whereas a QFC counterparty exercising a cross-default right is instead
acting against a distinct legal entity that is not itself in
resolution--the debtor's affiliate.
---------------------------------------------------------------------------
\31\ See 11 U.S.C. 362(a).
---------------------------------------------------------------------------
Title II of the Dodd-Frank Act and the Orderly Liquidation
Authority. Title II of the Dodd-Frank Act imposes stay requirements on
QFCs of financial companies that enter resolution under that Title. In
general, no financial firm (regardless of size) is too-big-to-fail and
a U.S. bank holding company (such as the top-tier holding company of a
U.S. GSIB) that fails would be resolved under the U.S. Bankruptcy Code.
Congress recognized, however, that a financial company might fail under
extraordinary circumstances in which an attempt to resolve it through
the bankruptcy process would have serious adverse effects on financial
stability in the United States. Title II of the Dodd-Frank Act
establishes the Orderly Liquidation Authority (OLA), an alternative
resolution framework intended to be used in rare circumstances to
manage the failure of a firm that poses a significant risk to the
financial stability of the United States in a manner that mitigates
such risk and minimizes moral hazard.\32\ Title II authorizes the
Secretary of the Treasury, upon the recommendation of other government
agencies and a determination that several preconditions are met, to
place a financial company into a receivership conducted by the FDIC as
an alternative to bankruptcy.\33\
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\32\ Section 204(a) of the Dodd-Frank Act, codified at 12 U.S.C.
5384(a).
\33\ See section 203 of the Dodd-Frank Act, codified at 12
U.S.C. 5383.
---------------------------------------------------------------------------
Title II empowers the FDIC to transfer the QFCs to a bridge
financial company or some other financial company that is not in a
resolution proceeding and should therefore be capable of performing
under the QFCs.\34\ To give the FDIC time to effect this transfer,
Title II temporarily stays QFC counterparties of the failed entity from
exercising termination, netting, and collateral liquidation rights
``solely by reason of or incidental to'' the failed entity's entry into
OLA resolution, its insolvency, or its financial condition.\35\ Once
the QFCs are transferred in accordance with the statute, Title II
permanently stays the exercise of default rights for those reasons.\36\
---------------------------------------------------------------------------
\34\ See 12 U.S.C. 5390(c)(9).
\35\ 12 U.S.C. 5390(c)(10)(B)(i)(I). This temporary stay
generally lasts until 5:00 p.m. eastern time on the business day
following the appointment of the FDIC as receiver.
\36\ 12 U.S.C. 5390(c)(10)(B)(i)(II).
---------------------------------------------------------------------------
Title II addresses cross-default rights through a similar
procedure. It empowers the FDIC to enforce contracts of subsidiaries or
affiliates of the failed covered financial company that are
``guaranteed or otherwise supported by or linked to the covered
financial company, notwithstanding any contractual right to cause the
termination, liquidation, or acceleration of such contracts based
solely on the insolvency, financial condition, or receivership of'' the
failed company, so long as, if such contracts are guaranteed or
otherwise supported by the covered financial company, the FDIC takes
certain steps to protect the QFC counterparties' interests by the end
of the business day following the company's entry into OLA
resolution.\37\
---------------------------------------------------------------------------
\37\ 12 U.S.C. 5390(c)(16).
---------------------------------------------------------------------------
These stay-and-transfer provisions of the Dodd-Frank Act are
intended to mitigate the threat posed by QFC default rights. At the
same time, the provisions allow appropriate protections for QFC
counterparties of the failed financial
[[Page 42887]]
company. The provisions stay only the exercise of default rights based
on the failed company's entry into resolution, the fact of its
insolvency, or its financial condition. Further, the stay period is
brief, unless the FDIC transfers the QFCs to another financial company
that is not in resolution (and should therefore be capable of
performing under the QFCs) or, if applicable, provides adequate
protection that the QFCs will be performed.
The Federal Deposit Insurance Act. Under the FDI Act, a failing
insured depository institution would generally enter a receivership
administered by the FDIC.\38\ The FDI Act addresses direct default
rights in the failed bank's QFCs with stay-and-transfer provisions that
are substantially similar to the provisions of Title II of the Dodd-
Frank Act discussed above.\39\ However, the FDI Act does not address
cross-default rights, leaving the QFC counterparties of the failed
depository institution's affiliates free to exercise any contractual
rights they may have to terminate, net, or liquidate collateral based
on the depository institution's entry into resolution. Moreover, as
with Title II of the Dodd-Frank Act, there is a possibility that a
court of a foreign jurisdiction might decline to enforce the FDI Act's
stay-and-transfer provisions under certain circumstances.
---------------------------------------------------------------------------
\38\ 12 U.S.C. 1821(c).
\39\ See 12 U.S.C. 1821(e)(8)-(10).
---------------------------------------------------------------------------
B. Notice of Proposed Rulemaking and General Summary of Comments
The proposal was intended to increase GSIB resolvability and
resiliency by addressing two QFC-related issues. First, the proposal
sought to address the risk that a court in a foreign jurisdiction may
decline to enforce the QFC stay-and-transfer provisions of Title II and
the FDI Act discussed above. Second, the proposal sought to address the
potential disruption that may occur if a counterparty to a QFC with an
affiliate of a GSIB entity that goes into resolution under the U.S.
Bankruptcy Code or the FDI Act exercises cross-default rights.
Scope of application. The proposal's requirements would have
applied to all ``covered entities.'' Under the proposal, ``covered
entity'' included: Any U.S. top-tier bank holding company identified as
a GSIB under the Board's rule establishing risk-based capital
surcharges for GSIBs (GSIB surcharge rule); \40\ any subsidiary of such
a bank holding company; and any U.S. subsidiary, U.S. branch, or U.S.
agency of a foreign GSIB.\41\ ``Covered entity'' did not include
national banks and Federal savings associations that are supervised by
the Office of the Comptroller of the Currency (OCC), because the OCC
was expected to issue, and ultimately did issue, a proposed rule that
would subject those institutions to requirements substantively
identical to those proposed by the Board's rule for covered entities.
---------------------------------------------------------------------------
\40\ 12 CFR 217.402; 80 FR 49106 (Aug. 14, 2015).
\41\ See proposed rule Sec. 252.81.
---------------------------------------------------------------------------
In the proposal, ``qualified financial contract'' or ``QFC'' was
defined to have the same meaning as in section 210(c)(8)(D) of the
Dodd-Frank Act,\42\ and included, among other things, derivatives,
repos, and securities borrowing and lending agreements. Subject to the
exceptions discussed below, the proposal's requirements would have
applied to any QFC to which a covered entity is party (covered QFC).
Under the proposal, a covered entity would have been required to
conform pre-existing QFCs if a covered entity enters into a new QFC
with a counterparty or its affiliate.
---------------------------------------------------------------------------
\42\ 12 U.S.C. 5390(c)(8)(D). See proposed rule Sec. 252.81.
---------------------------------------------------------------------------
Required contractual provisions related to the U.S. Special
Resolution Regimes. Under the proposal, covered entities would have
been required to ensure that covered QFCs include contractual terms
explicitly providing that any default rights or restrictions on the
transfer of the QFC are limited to at least the same extent as they
would be pursuant to the OLA and the FDI Act (U.S. Special Resolution
Regimes).\43\ The proposed requirements were not intended to imply that
the statutory stay-and-transfer provisions would not in fact apply to a
given QFC, but rather to help ensure that all covered QFCs would be
treated the same way in the context of an FDIC receivership under the
Dodd-Frank Act or the FDI Act. This provision was intended to address
the first issue listed above and to decrease the QFC-related threat to
financial stability posed by the failure and resolution of an
internationally active GSIB. This section of the proposal was also
consistent with analogous legal requirements that have been imposed in
other national jurisdictions \44\ and with the Financial Stability
Board's ``Principles for Cross-border Effectiveness of Resolution
Actions.'' \45\
---------------------------------------------------------------------------
\43\ See proposed rule Sec. 252.83.
\44\ See, e.g., Bank of England Prudential Regulation Authority,
Policy Statement, ``Contractual stays in financial contracts
governed by third-country law'' (Nov. 2015), http://www.bankofengland.co.uk/pra/Documents/publications/ps/2015/ps2515.pdf.
\45\ Financial Stability Board, ``Principles for Cross-border
Effectiveness of Resolution Actions'' (Nov. 3, 2015), http://www.fsb.org/wp-content/uploads/Principles-for-Cross-border-Effectiveness-of-Resolution-Actions.pdf.
The Financial Stability Board (FSB) was established in 2009 to
coordinate the work of national financial authorities and
international standard-setting bodies and to develop and promote the
implementation of effective regulatory, supervisory, and other
financial sector policies to advance financial stability. The FSB
brings together national authorities responsible for financial
stability in 24 countries and jurisdictions, as well as
international financial institutions, sector-specific international
groupings of regulators and supervisors, and committees of central
bank experts. See generally Financial Stability Board, http://www.fsb.org.
---------------------------------------------------------------------------
Prohibited cross-default rights. Under the proposal, a covered
entity would have been prohibited from entering into covered QFCs that
would allow the exercise of cross-default rights--that is, default
rights related, directly or indirectly, to the entry into resolution of
an affiliate of the direct party--against it.\46\ Covered entities
would have been similarly prohibited from entering into covered QFCs
that included a restriction on the transfer of a credit enhancement
supporting the QFC from the covered entity's affiliate to a transferee
upon the entry into resolution of the affiliate.
---------------------------------------------------------------------------
\46\ See proposed rule Sec. 252.83(b).
---------------------------------------------------------------------------
The Board did not propose to prohibit a covered entity from
entering into QFCs that allow its counterparties to exercise direct
default rights against the covered entity. Under the proposal, a
covered entity also could, to the extent not inconsistent with Title II
or the FDI Act, enter into a QFC that grants its counterparty the right
to terminate the QFC if the covered entity fails to perform its
obligations under the QFC.
Industry-developed protocol. As an alternative to bringing their
covered QFCs into compliance with the requirements set out in the
proposed rule, covered entities would have been permitted to comply
with the requirements of the proposed rule by adhering to the
International Swaps and Derivatives Association (ISDA) 2015 Universal
Resolution Stay Protocol, including the Securities Financing
Transaction Annex and the Other Agreements Annex (together, the
``Universal Protocol'').\47\ The preamble to the proposal explained
that the Board viewed the Universal Protocol as achieving an outcome
consistent with the outcome intended by the requirements of the
proposed rule by
[[Page 42888]]
similarly limiting direct default rights and cross-default rights.
---------------------------------------------------------------------------
\47\ ISDA, ``Attachment to the ISDA 2015 Universal Resolution
Stay Protocol,'' (Nov. 4, 2015), http://assets.isda.org/media/ac6b533f-3/5a7c32f8-pdf/. See proposed rule Sec. 252.85(a).
---------------------------------------------------------------------------
Process for approval of enhanced creditor protection conditions.
The proposal also would have allowed the Board, at the request of a
covered entity, to approve as compliant with the proposal covered QFCs
with creditor protections other than those that would otherwise be
permitted under section 252.84 of the proposal.\48\ The Board would
have been permitted to approve such a request if, in light of several
enumerated considerations,\49\ the alternative creditor protections
would mitigate risks to the financial stability of the United States
presented by a GSIB's failure to at least the same extent as the
proposed requirements.
---------------------------------------------------------------------------
\48\ See proposed rule Sec. 252.85.
\49\ See proposed rule Sec. 252.85(c).
---------------------------------------------------------------------------
Amendments to certain definitions in the Board's capital and
liquidity rules. The proposal also would have amended certain
definitions in the Board's capital and liquidity rules to help ensure
that the regulatory capital and liquidity treatment of QFCs to which a
covered entity is party would not be affected by the proposed
restrictions on such QFCs. Specifically, the proposal would have
amended the definition of ``qualifying master netting agreement'' in
the Board's regulatory capital and liquidity rules and would similarly
amend the definitions of the terms ``collateral agreement,'' ``eligible
margin loan,'' and ``repo-style transaction'' in the Board's regulatory
capital rules.
Comments on the Proposal. The Board received approximately 30
comments on the proposed rule from banking organizations, trade
associations, public interest advocacy groups, and private individuals.
Board staff also met with some commenters at their request to discuss
their comments on the proposal, and summaries of these meetings may be
found on the Board's public Web site.
A number of commenters, including GSIBs that would be subject to
the requirements of the proposal, expressed strong support for the
proposed rule as a well-considered effort to reduce systemic risk with
minimal burden and as one of the last important steps to ensure a more
efficient and orderly resolution process for all covered entities and
thereby to protect the stability of the U.S. financial system. Other
commenters, however, expressed concern with the proposed rule. These
commenters generally argued that the proposal should not restrict
contractual rights of GSIB counterparties and contended that the
proposal shifts the costs of resolving the covered entities to non-
defaulting counterparties. Some commenters argued that the proposal
would not assuredly mitigate systemic risk, as the requirements could
result in increased market and credit risk for QFC counterparties of a
GSIB. Commenters also argued that it would be more appropriate for
Congress to impose the proposal's restrictions on contractual rights
through the legislative process rather than for the Board to do so
through a regulation.
As described above, the proposal applied to ``covered entities,''
which was defined to mean all U.S. GSIBs and their subsidiaries, as
well as the U.S. operations (subsidiaries, branches, and agencies) of
GSIBs that are foreign banking organizations. The proposal generally
defined ``subsidiary'' as an entity controlled by a GSIB under the Bank
Holding Company Act (BHC Act). Commenters urged the Board to move to a
financial consolidation standard to define the subsidiaries of covered
entities, arguing that the concept of control under the BHC Act
includes entities (1) that are not under the operational control of the
GSIB and over whom the GSIB does not have the practical ability to
require remediation and (2) which are unlikely to raise the types of
concerns for the orderly resolution of GSIBs targeted by the proposal.
For similar reasons, these commenters argued that, for purposes of the
requirement that a covered entity conform existing QFCs if a covered
entity enters into a new QFC with a counterparty or its affiliate, a
counterparty's ``affiliate'' should also be defined by reference to
financial consolidation rather than BHC Act control.
Commenters also expressed concern that the definition of ``covered
QFCs'' under the proposal was overly broad. The proposal required a
covered QFC to explicitly provide that it is subject to the stay-and-
transfer provisions of Title II and the FDI Act and prohibited a
covered entity from being a party to a QFC that would allow the
exercise of cross-default rights. Commenters argued that the final rule
should exclude QFCs that do not contain any contractual transfer
restrictions, direct default rights, or cross-default rights, as these
QFCs do not give rise to the risk that counterparties will exercise
their contractual rights in a manner that is inconsistent with the
provisions of the U.S. Special Resolution Regimes. Commenters also
urged the Board to exclude QFCs governed by U.S. law from the
requirement that QFCs explicitly ``opt in'' to the U.S. Special
Resolution Regimes since it is already sufficiently clear that such
QFCs are subject to the stay-and-transfer provisions of Title II and
the FDI Act. With respect to the proposal's prohibition against
provisions that would allow the exercise of cross-default rights in
covered QFCs of a GSIB, commenters argued that the final rule should
clarify that QFCs that do not contain such cross-default rights or
transfer restrictions regarding related credit enhancements are not
within the scope of the prohibition.
Commenters also requested that certain types of contracts that may
include transfer or default rights subject to the proposal's
requirements (e.g., warrants; certain commodity contracts, including
commodity swaps; certain utility and gas supply contracts; certain
retail customer and investment advisory agreements; securities
underwriting agreements; securities lending authorization agreements)
be excluded from all requirements of the final rule because these types
of contracts do not raise the risks to the resolution of a covered
entity or financial stability that are the target of this final rule
and because certain existing contracts of these types would be
difficult, if not impossible, to amend. Commenters also requested that
securities contracts that typically settle in the short term or that
typically include only transfer restrictions and not default rights
similarly be excluded from all requirements of the final rule because
they do not impose ongoing or continuing obligations on either party
after settlement. In all of the above cases, commenters argued that
remediation of such outstanding contracts would be burdensome with no
meaningful resolution benefits. Certain commenters also urged the Board
to apply the final rule only to contracts entered into after the final
rule's effective date and not to contracts existing as of the final
rule's effective date.
As noted above, the proposal would have deemed compliant covered
QFCs amended by the existing Universal Protocol (which allows for
creditor protections in addition to those otherwise permitted by the
proposed rule). Commenters generally supported this aspect of the
proposal, although they requested express clarification that adherence
to the existing Universal Protocol would satisfy all of the
requirements of the final rule. Commenters urged that the final rule
should also provide a safe harbor for a future ISDA protocol that would
be substantially similar to the existing Universal Protocol except that
it would seek to address the specific needs of buy-side market
participants, such as
[[Page 42889]]
asset managers, insurance companies, and pension funds who are
counterparties to QFCs with GSIBs, to allow, for example, entity-by-
entity adherence and the exclusion of certain foreign special
resolution regimes.
Commenters expressed support for the exemption in the proposal for
cleared QFCs but requested that this exemption be broadened to extend
to the client leg of a cleared back-to-back transaction and also to
exclude any contract cleared, processed, or settled on a financial
market utility (FMU) as well as any QFC conducted according to the
rules of an FMU. Commenters also requested an exemption for QFCs with
sovereign entities and central banks. Commenters further requested a
longer period of time for covered entities to conform covered QFCs with
certain types of counterparties to comply with the requirements of the
final rule. Commenters also requested that the Board coordinate with
other regulatory agencies, consider comments submitted to the OCC
regarding its proposal and from entities not regulated by the Board,
and finalize a rule with conformance periods consistent with the OCC's
final rule. In addition, commenters requested confirmation that
modifications to contracts to comply with this rule would not trigger
other regulatory requirements (e.g., margin requirements for non-
cleared swaps) or impact the enforceability of QFCs. The Board has
considered the comments received on this proposal, including those of
entities not regulated by the Board, as well as the comments submitted
to the OCC and FDIC regarding their respective proposals, and these
comments and changes in the final rule are described in more detail
throughout the remainder of this SUPPLEMENTARY INFORMATION.
C. Overview of Final Rule
The Board is adopting this final rule to improve the resolvability
and resilience of GSIBs and thereby reduce threats to financial
stability. The Board has made a number of changes to the proposal in
response to concerns raised by commenters, as further described below.
The final rule is intended to facilitate the orderly resolution of
the most systemically important banking firms--the GSIBs--by limiting
the ability of the firms' counterparties to terminate QFCs upon the
entry of the GSIB or one or more of its affiliates into resolution. The
rule requires the inclusion of contractual restrictions on the exercise
of certain default rights in those QFCs. In particular, the final rule
requires the QFCs of covered entities to contain contractual provisions
that opt into the stay-and-transfer treatment of the FDI Act and the
Dodd-Frank Act to reduce the risk that the stay-and-transfer treatment
would be challenged by a QFC counterparty or a court in a foreign
jurisdiction. The final rule also prohibits covered entities from
entering into QFCs that contain cross-default rights, subject to
certain creditor protection exceptions that would not be expected to
interfere with an orderly resolution.
The final rule also facilitates the implementation of the Universal
Protocol, which can extend, through contractual agreement, the
application of the resolution frameworks of the FDI Act and the Dodd-
Frank Act to all QFCs entered into by a GSIB and its subsidiaries,
including QFCs entered into by covered entities outside of the United
States, and establishes restrictions on cross-default rights that are
similar to those in the final rule. The final rule is necessary to
implement the Universal Protocol provisions regarding the resolution of
a GSIB under the U.S. Bankruptcy Code, as these provisions do not
become effective until implemented by U.S. regulations. To support
further adherence to the Universal Protocol, the final rule creates a
safe harbor allowing covered entities to sign up to the Universal
Protocol and thereby amend their QFCs pursuant to the Universal
Protocol as an alternative to implementing the restrictions of the
final rule on a counterparty-by-counterparty basis. In addition, the
final rule provides that covered QFCs amended pursuant to adherence of
a covered entity to a new protocol (the ``U.S. Protocol'') would be
deemed to conform to the requirements of the final rule. The U.S.
Protocol may differ from the Universal Protocol in the certain respects
discussed below, but otherwise must be substantively identical to the
Universal Protocol.
The final rule requires covered entities to conform certain covered
QFCs to the requirements of the final rule on the first day of the
first calendar quarter that begins a year after issuance of the final
rule (first compliance date) and phases in conformance requirements
with respect to all covered QFCs over a two-year period depending on
the type of counterparty. As explained below, a covered entity
generally is required to conform pre-existing QFCs only if the covered
entity or an affiliate of the covered entity enters into a new QFC with
the same counterparty or a consolidated affiliate of the counterparty
on or after the first compliance date.
1. Covered Entities
The final rule continues to apply to ``covered entities,'' which
generally are U.S. GSIBs and their subsidiaries and the U.S. operations
of foreign GSIBs. ``Subsidiary'' continues to be defined in the final
rule by reference to BHC Act control. Because the FDIC and OCC are
expected to finalize substantively identical final rules to that of the
Board, the definition of ``covered entity'' in the final rule excludes
state savings associations and state nonmember banks (FSIs), which are
supervised by the FDIC, and GSIB subsidiaries (e.g., national banks),
U.S. branches, and U.S. agencies that are supervised by the OCC. The
final rule refers to FSIs and entities supervised by the OCC (e.g.,
national banks) that would be covered entities but for this exclusion
as ``excluded banks.'' \50\ As discussed below, certain other types of
GSIB subsidiaries, such as merchant banking portfolio companies, are
also excluded from the final rule.
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\50\ See final rule Sec. 252.81 for definitions of ``excluded
bank'' and ``FSI.'' See also 12 U.S.C. 1813.
---------------------------------------------------------------------------
2. Covered Qualified Financial Contracts
The final rule, like the proposal, defines ``qualified financial
contract'' or ``QFC'' to have the same meaning as in section
210(c)(8)(D) of the Dodd-Frank Act \51\ and would include, among other
things, derivatives, repos, and securities lending agreements.\52\
Subject to the exceptions discussed below, the final rule's
requirements apply to any QFC to which a covered entity is party
(covered QFC). The final rule makes clear that covered entities do not
need to conform QFCs that have no transfer restrictions, direct default
rights, or cross-default rights, as these QFCs have no provisions that
the rule is intended to address.\53\ The final rule also excludes
retail investment advisory agreements and certain existing
warrants.\54\ It also provides the Board with authority to exempt one
or more covered entities from conforming certain contracts or types of
contracts to the requirements of the final rule after considering, in
addition to any other factor the Board deems relevant, the burden the
exemption would relieve and the potential impact of the exemption on
the resolvability of the covered entity or its affiliates.\55\
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\51\ 12 U.S.C. 5390(c)(8)(D).
\52\ See final rule Sec. 252.81; proposed rule Sec. 252.81.
\53\ See final rule Sec. 252.84(a).
\54\ See final rule Sec. 252.88(c).
\55\ See final rule Sec. 252.88(d).
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The final rule also makes clear that a covered entity must conform
existing
[[Page 42890]]
QFCs with a counterparty if the GSIB group (i.e., the covered entity or
its affiliates that are covered entities or excluded banks) enters into
a new QFC with that counterparty or its affiliate, defined by reference
to financial consolidation principles. In particular, the final rule
provides that a covered QFC includes a QFC that the covered entity
entered, executed, or otherwise became a party to before the first
compliance date of this final rule if the covered entity or any
affiliate that is a covered entity or excluded bank also enters,
executes, or otherwise becomes a party to a QFC with the same person or
a consolidated affiliate of that person on or after the first
compliance date.\56\ ``Consolidated affiliate'' is a defined term in
the final rule that is defined by reference to financial consolidation
principles.\57\
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\56\ See final rule Sec. 252.82(c).
\57\ See final rule Sec. 252.81.
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3. Required Contractual Provisions Related to the U.S. Special
Resolution Regimes
Under the final rule, covered entities are required to ensure that
covered QFCs include contractual terms explicitly providing that any
default rights or restrictions on the transfer of the QFC are limited
to the same extent as they would be pursuant to the U.S. Special
Resolution Regimes.\58\ However, any covered QFC that is governed under
U.S. law and involves only parties (other than the covered entity) that
are domiciled in, incorporated in, organized under, or whose principal
place of business is located in the United States, including any state,
or that is a U.S. branch or agency (U.S. counterparties) is also
excluded from the requirements of the final rule relating to Title II
of the Dodd-Frank Act and the FDI Act because it is sufficiently clear
that the stay-and-transfer provisions of those acts would be
enforceable.\59\
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\58\ See final rule Sec. 252.83.
\59\ See final rule Sec. 252.83(a).
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4. Prohibited Cross-Default Rights
Under the final rule, a covered entity is prohibited from entering
into covered QFCs that would allow the exercise of cross-default
rights--that is, default rights related, directly or indirectly, to the
entry into resolution of an affiliate of the direct party--against
it.\60\ Covered entities are similarly prohibited from entering into
covered QFCs that would restrict the transfer of a credit enhancement
supporting the QFC from the covered entity's affiliate to a transferee
upon the entry into resolution of the affiliate.\61\
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\60\ See final rule Sec. 252.84(b).
\61\ See id.
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The final rule does not prohibit covered entities from entering
into QFCs that provide their counterparties with direct default rights
against the covered entity. Under the final rule, a covered entity may
be party to a QFC that, to the extent not inconsistent with Title II or
the FDI Act, provides the counterparty with the right to terminate the
QFC if the covered entity fails to perform its obligations under the
QFC.
5. Industry-Developed Protocol
As an alternative to bringing their covered QFCs into compliance
with the requirements of the final rule, the final rule allows covered
entities to comply with the rule by adhering to the Universal
Protocol.\62\ The final rule also permits compliance with the final
rule through adherence to a new protocol (the U.S. Protocol) that is
the same as the existing Universal Protocol but for minor changes
intended to encourage a broader range of QFC counterparties to adhere
only with respect to covered entities and excluded banks. The Universal
Protocol and the U.S. Protocol differ from the requirements of this
final rule in certain respects. Nevertheless, as described in greater
detail below, the final rule allows compliance through adherence to
these protocols in light of the fact that the protocols contain certain
desirable features that the final rule lacks and produce outcomes
substantially similar to this final rule.
---------------------------------------------------------------------------
\62\ See final rule Sec. 252.85(a).
---------------------------------------------------------------------------
6. Process for Approval of Enhanced Creditor Protection Conditions
The final rule also allows the Board, at the request of a covered
entity, to approve as compliant with the final rule covered QFCs with
creditor protections other than those that would otherwise be permitted
under section 252.84 of the final rule.\63\ The Board could approve
such a request if, in light of several enumerated considerations, the
alternative approach would prevent or mitigate risks to the financial
stability of the United States presented by a GSIB's failure and would
protect the safety and soundness of bank holding companies and state
member banks to at least the same extent as the final rule's
requirements.\64\
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\63\ See final rule Sec. 252.85(c).
\64\ See final rule Sec. 252.85(c)-(d).
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7. Amendments to Certain Definitions in the Board's Capital and
Liquidity Rules
The final rule also amends certain definitions in the Board's
capital and liquidity rules to help ensure that the regulatory capital
and liquidity treatment of QFCs to which a covered entity is party is
not affected by the proposed restrictions on such QFCs. Specifically,
the final rule amends the definition of ``qualifying master netting
agreement'' in the Board's regulatory capital and liquidity rules and
similarly amends the definitions of the terms ``collateral agreement,''
``eligible margin loan,'' and ``repo-style transaction'' in the Board's
regulatory capital rules.
D. Consultation With U.S. Financial Regulators, the Council, and
Foreign Authorities
In developing this final rule, the Board consulted with the FDIC,
the OCC, and the Financial Stability Oversight Council (Council).\65\
The final rule reflects input received by the Board during this
consultation process. Furthermore, the Board has consulted with, and
expects to continue to consult with, foreign financial regulatory
authorities regarding this final rule and the establishment of other
standards that would maximize the prospects for the cooperative and
orderly cross-border resolution of a failed GSIB on an international
basis.\66\
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\65\ One commenter also requested that the Board consult with
other agencies with entities under their jurisdiction affected by
the final rule. Several commenters requested that the Board consult
with the OCC in developing its final rule and coordinate its final
rule with that of the OCC. Board staff has consulted with the
Council as well as the FDIC and OCC in developing this final rule.
\66\ Certain commenters also requested that the Board consult
with foreign regulatory authorities in developing its final rule.
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The OCC is expected to finalize a rulemaking that would subject
national banks, Federal savings associations, Federal branches, and
Federal agencies of GSIBs to requirements substantively identical to
those proposed here for covered entities. Similarly, the FDIC is
expected to finalize a rulemaking that would subject state nonmember
bank and state savings association subsidiaries of GSIBs to
requirements substantively identical to those proposed here for covered
entities. The Board has consulted with the OCC and FDIC in the
development of their respective final rules. The banking agencies have
endeavored to harmonize their respective rules to the extent possible
and to provide specificity and clarity in the final rule to minimize
the possibility of conflicting interpretations or uncertainty in their
application. Moreover, the banking agencies intend to consult with each
other and coordinate as needed regarding implementation of the final
rule.
[[Page 42891]]
II. Restrictions on QFCs of GSIBs
A. Covered Entities (Section 252.82(b) of the Final Rule)
The proposed rule applied to ``covered entities,'' which included
(a) any U.S. GSIB top-tier bank holding company, (b) any subsidiary of
such a bank holding company that is not a ``covered bank,'' and (c) the
U.S. operations of any foreign GSIB, with the exception of any
``covered bank.'' In the proposal, the term ``covered bank'' was
defined to include certain entities, such as certain national banks,
that are supervised by the OCC. Covered banks would have been exempt
from the requirements of the proposal because the OCC was expected to
issue a proposed rule that would impose substantively identical
requirements on covered banks.\67\ Commenters supported this exemption
for QFCs of covered banks on the basis that these banks should not have
to comply with two sets of rules.\68\
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\67\ Section 252.88 of the Board's proposal also clarified that
covered entities would not be required to conform covered QFCs with
respect to a part of a covered QFC that a covered bank also would be
required to conform under the proposed rule that the OCC
subsequently issued.
\68\ Commenters requested further clarification on the
interaction between the final rules of the Board and the OCC to
avoid legal uncertainty. As noted above, the OCC and FDIC are
expected to finalize rules that are substantively identical to this
final rule, and the banking agencies are expected to coordinate in
the interpretation of the rules. Section 252.88(b) of the final
rule, which addresses potential overlap between the agencies' final
rules, has been clarified in response to commenters' requests.
Section 252.88(b) is discussed in more detail below.
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Under the proposal, covered entities included the entities
identified as U.S. GSIB top-tier holding companies under the Board's
GSIB surcharge rule \69\ as well as all subsidiaries of U.S. GSIBs
(other than covered banks, as defined in the proposal).\70\ The
definition of ``subsidiary'' under the proposal included any company
that is owned or controlled directly or indirectly by another company,
where the term ``control'' was defined by reference to the BHC Act.\71\
The BHC Act definition of control includes ownership, control or the
power to vote 25 percent of any class of voting securities; control in
any manner of the election of a majority of the directors or trustees;
or exercise of a controlling influence over the management or
policies.\72\
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\69\ 12 CFR 217.402. See also 80 FR 49082 (Aug. 14, 2015).
\70\ See proposed rule Sec. 252.82(a)(1).
\71\ See 12 CFR 252.2.
\72\ See 12 U.S.C. 1841(a).
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A few commenters urged the Board not to expand the scope of covered
entity to include non-GSIBs, arguing that such an expansion would
exceed the Board's statutory authority under the Dodd-Frank Act. The
Board is not including non-GSIBs as covered entities in its final rule.
A number of commenters urged the Board to move to a financial
consolidation standard to define a ``subsidiary'' of a covered entity
instead of BHC Act control.\73\ These commenters argued that, under
Generally Accepted Accounting Principles, a company generally would
consolidate an entity in which it holds a majority voting interest or
over which it has the power to direct the most significant economic
activities, to the extent it also holds a variable interest in the
entity. In addition, commenters pointed out that financially
consolidated subsidiaries are often subject to operational control and
generally fully integrated into the parent's enterprise-wide
governance, policies, procedures, control frameworks, business
strategies, information technology systems, and management systems.
These commenters pointed out that the concept of BHC Act control was
designed to serve other policy purposes (e.g., separation between
banking and commercial activities). A number of commenters argued that
BHC Act control may include an entity that is not under the day-to-day
operational control of the GSIB and over whom the GSIB does not have
the practical ability to require remediation of that entity's QFCs to
comply with the proposed rule. Moreover, commenters contended that
entities that are not consolidated with a GSIB for financial reporting
purposes are unlikely to raise the types of concerns for the orderly
resolution of GSIBs targeted by the proposal. Commenters also noted
that the ISDA master agreements and the Universal Protocol define
``affiliate'' by reference to ownership of a majority of the voting
power of an entity or person. For these reasons, commenters urged the
Board to define the term ``subsidiary'' of a covered entity based on
financial consolidation under the final rule.
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\73\ Commenters generally expressed a similar view with respect
to the definition of ``affiliate'' of a covered entity as the term
is used in sections 252.83 and 84 of the proposed rule. That term
which was similarly defined by reference to BHC Act control under
the proposal.
---------------------------------------------------------------------------
Commenters urged that, regardless of whether a financial
consolidation standard is adopted for the purpose of defining
``subsidiary,'' the final rule should exclude from the definition of
``covered entity'' entities over which the covered entity does not
exercise operational control, such as merchant banking portfolio
companies, section 2(h)(2) companies, joint ventures, sponsored funds
as distinct from their sponsors or investment advisors, securitization
vehicles, entities in which the covered entity holds only a minority
interest and does not exert a controlling influence, and subsidiaries
held pursuant to provisions for debt previously contracted in good
faith (DPC subsidiaries).\74\ With respect to merchant banking
authority, which allows a financial holding company to make a majority
or minority investment in a portfolio company that is engaged in
activity that is not financial in nature, certain commenters noted that
section 4(k) of the BHC Act prohibits the financial holding company
from routinely managing or operating the portfolio company except as
may be necessary or required to obtain a reasonable return on
investment upon resale or other disposition of the portfolio
company.\75\ Regarding sponsored funds, commenters argued that each
sponsored or advised fund is a separate legal entity that is distinct
from its sponsor or investment advisor regardless of whether the fund
is consolidated and that the sponsor or advisor has no claim on the
fund's assets and may not use the fund's assets for its benefit.
---------------------------------------------------------------------------
\74\ See, e.g., 12 U.S.C. 1842(a)(A)(ii), 1843(c)(2); 12 CFR
225.12(b), 225.22(d)(1).
\75\ 12 U.S.C. 1843(k)(4)(H)(iv); 12 CFR 225.171(a).
---------------------------------------------------------------------------
In terms of foreign GSIBs, certain commenters argued that foreign
banking organization (FBO) subsidiaries for which the FBO has been
given special relief by Board order not to hold the subsidiary under an
intermediate holding company should not be included in the definition
of covered entity, even if such entities would be consolidated under
financial consolidation principles.\76\ These commenters argued that,
since neither the covered entity nor the foreign GSIB parent would
provide credit support to these entities or name such entities in a
cross-default provision in a QFC or related agreement, the failure of
any of these types of entities would be unlikely to affect QFCs entered
into by the covered entity or any other affiliate. These commenters
further noted that the few such requests that have been granted by the
Board often involved situations in which the FBO did not have
sufficient operational control over the entity to ensure its
compliance. Commenters also requested that U.S.
[[Page 42892]]
branches and agencies of FBOs be excluded from the definition of
``covered entity'' and ``U.S. operations'' of foreign GSIBs where the
foreign GSIB's home country legal framework meets the objectives of the
final rule. These commenters argued that the requirements of the final
rule would be duplicative of requirements on a foreign GSIB's U.S.
branches and agencies if those entities' QFCs are already subject to
existing and substantially equivalent resolution powers in the home
country, without a proportionate incremental benefit to their
resolvability or reduction in risk to U.S. financial stability.\77\
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\76\ Board orders granting requests from FBOs for such treatment
can be found at Regulation YY Foreign Banking Organization Requests,
https://www.federalreserve.gov/supervisionreg/regulation-yy-foreign-banking-organization-requests.htm.
\77\ In the alternative, these commenters requested that the
requirements only apply to U.S. branches of foreign GSIBs insofar as
the home resolution regime and group resolution strategy would not
adequately ensure that early termination rights, including cross-
default rights against the U.S. IHC or subsidiaries, will not be
triggered in resolution.
---------------------------------------------------------------------------
Under the final rule, a ``covered entity'' is generally (a) any
U.S. GSIB top-tier bank holding company; (b) any subsidiary of such a
company that is not a national bank, Federal savings association,
Federal branch, Federal agency, or FSI; and (c) the U.S. operations of
any foreign GSIB that is not a national bank, Federal savings
association, Federal branch, Federal agency, or FSI, with certain
specified exceptions.\78\ ``FSI'' is defined to include state nonmember
banks and state savings associations, which are supervised by the
FDIC.\79\ National banks, Federal savings associations, Federal
branches, Federal agencies, and FSIs that are exempt from the final
rule are ``excluded banks'' under the final rule.\80\ Excluded banks
are exempt from the requirements of this final rule because the OCC and
FDIC are expected to issue final rules that would impose substantively
identical requirements on excluded banks in the near future.\81\
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\78\ See final rule Sec. 252.82(b).
\79\ The terms ``state non-member bank'' and ``state savings
association'' are defined in the final rule by reference to section
3 of the Federal Deposit Insurance Act, 12 U.S.C. 1813. See final
rule Sec. 252.81.
\80\ See final rule Sec. 252.81. However, excluded banks do not
include subsidiaries of a GSIB that are DPC subsidiaries or
portfolio companies owned under the Small Business Investment Act of
1956, or public welfare investments.
\81\ Section 252.88(b) of the final rule, like the proposal,
clarifies that covered entities are not required to conform covered
QFCs with respect to a part of a covered QFC that an excluded bank
also would be required to conform under the final rules that the OCC
and FDIC are expected to issue. Such overlap could occur, for
example, where a bank holding company that is a covered entity
provides, as part of a master agreement governing swaps, a guaranty
for a swap between a subsidiary that is an excluded bank and the
excluded bank's counterparty. See also 12 U.S.C
5390(c)(8)(D)(vi)(V), (viii). As requested by commenters, this
provision in the final rule has been revised to further clarify its
application.
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U.S. GSIB bank holding companies. As in the proposal, covered
entities include the entities identified as U.S. GSIB top-tier holding
companies under the Board's GSIB surcharge rule.\82\ Under the GSIB
surcharge rule, a U.S. top-tier bank holding company subject to the
advanced approaches rule \83\ must determine whether it is a GSIB by
applying a multifactor methodology established by the Board.\84\ The
methodology evaluates a banking organization's systemic importance on
the basis of its attributes in five broad categories: Size,
interconnectedness, cross-jurisdictional activity, substitutability,
and complexity.\85\
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\82\ See final rule Sec. 252.82(b)(1); 12 CFR 217.402.
\83\ 12 CFR part 217, subpart E.
\84\ 12 CFR 217.402, 217.404.
\85\ 12 CFR 217.404.
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Accordingly, the methodology provides a tool for identifying those
banking organizations whose failure or material distress would pose
especially large risks to the financial stability of the United States.
Improving the orderly resolution and resolvability of such firms,
including by reducing risks associated with their QFCs, would be an
important step toward achieving the goals of the Dodd-Frank Act. The
final rule's focus on GSIBs is also in keeping with the Dodd-Frank
Act's mandate that more stringent prudential standards be applied to
the most systemically important bank holding companies.\86\ Moreover,
several of the attributes that feed into the determination of whether a
given firm is a GSIB incorporate aspects of the firm's QFC activity.
These attributes include the firm's total exposures, its intra-
financial system assets and liabilities, its notional amount of over-
the-counter derivatives, and its cross-jurisdictional claims and
liabilities.
---------------------------------------------------------------------------
\86\ 12 U.S.C. 5365(a)(1)(B).
---------------------------------------------------------------------------
Under the GSIB surcharge rule's methodology, there are currently
eight U.S. GSIBs: Bank of America Corporation, The Bank of New York
Mellon Corporation, Citigroup Inc., Goldman Sachs Group, Inc., JPMorgan
Chase & Co., Morgan Stanley Inc., State Street Corporation, and Wells
Fargo & Company. This list may change in the future in light of changes
to the relevant attributes of the current U.S. GSIBs and of other large
U.S. bank holding companies.
U.S. GSIB subsidiaries. Covered entities also include all
subsidiaries of the U.S. GSIBs (other than excluded banks and the
exceptions described below).\87\ U.S. GSIBs generally enter into QFCs
through subsidiary legal entities rather than through the top-tier
holding company.\88\ Therefore, in order to increase GSIB resilience
and resolvability by addressing the potential obstacles to orderly
resolution posed by QFCs, it is necessary to apply the restrictions to
the U.S. GSIBs' subsidiaries. In particular, to facilitate the
resolution of a GSIB under an SPOE strategy, in which only the top-tier
holding company would enter a resolution proceeding while its
subsidiaries would continue to meet their financial obligations, or an
MPOE strategy where an affiliate of an entity that is otherwise
performing under a QFC enters resolution, it is necessary to ensure
that those subsidiaries or affiliates do not enter into QFCs that
contain cross-default rights that the counterparty could exercise based
on the holding company's or an affiliate's entry into resolution (or
that any such cross-default rights are stayed when the holding company
enters resolution). Moreover, including U.S. and non-U.S. entities of a
U.S. GSIB as covered entities should help ensure that such cross-
default rights do not affect the ability of performing and solvent
entities of a GSIB--regardless of jurisdiction--to remain outside of
resolution proceedings.
---------------------------------------------------------------------------
\87\ See final rule Sec. 252.82(b)(2).
\88\ Under the clean holding company component of the Board's
recent TLAC final rule, the top-tier holding companies of U.S. GSIBs
would be prohibited from entering into direct QFCs with third
parties. See 82 FR 8266, 8298 (Jan. 24, 2017).
---------------------------------------------------------------------------
``Subsidiary'' in the final rule continues to be defined by
reference to BHC Act control, as does the definition of ``affiliate.''
\89\ The final rule does not define covered entities to include only
those subsidiaries of GSIBs that are financially consolidated, as
requested by certain commenters. Defining ``subsidiary'' and
``affiliate'' by reference to BHC Act control is consistent with the
definitions of those terms in the FDI Act and Title II of the Dodd-
Frank Act. Specifically, Title II permits the FDIC, as receiver of a
covered financial company or as receiver for its subsidiary, to enforce
QFCs and other contracts of subsidiaries and affiliates, defined by
reference to the BHC Act, notwithstanding cross-default rights based
solely on the insolvency, financial condition, or receivership of the
covered financial company.\90\ Therefore, maintaining consistent
definitions of subsidiary and affiliate with Title II should better
ensure that QFC stays may be effected in resolution under a U.S.
Special Resolution Regime. As covered entities are subject to the
activity
[[Page 42893]]
restrictions and other requirements of the BHC Act, they should already
know all of their BHC Act-controlled subsidiaries and be familiar with
BHC Act control principles.\91\ Moreover, GSIBs should be able to rely
on governance rights and other negotiated mechanisms to ensure that
such subsidiaries conform their QFCs to the final rule's requirements.
---------------------------------------------------------------------------
\89\ See 12 CFR 252.2.
\90\ 12 U.S.C. 5390(c)(16).
\91\ For example, a covered entity may own more than 5 percent
(and less than 25 percent) of the voting shares of a registered
investment company for which the covered entity provides investment
advisory, administrative, and other services, and has a number of
director and officer interlocks, without controlling the fund for
purposes of the BHC Act. See letter to H. Rodgin Cohen, Esq.,
Sullivan & Cromwell (First Union Corp.), from Jennifer J. Johnson,
Secretary, Board of Governors of the Federal Reserve System (June
24, 1999) (finding that a bank holding company does not control a
mutual fund for which it provides investment advisory and other
services and that complies with the limitations of section 4(c)(7)
of the BHC Act (12 U.S.C. 1843(c)(7)), so long as (i) the bank
holding company reduces its interest in the fund to less than 25
percent of the fund's voting shares after a six-month period, and
(ii) a majority of the fund's directors are independent of the bank
holding company and the bank holding company cannot select a
majority of the board); see also 12 CFR 225.86(b)(3) (authorizing a
financial holding company to organize, sponsor, and manage a mutual
fund so long as (i) the fund does not exercise managerial control
over the entities in which the fund invests, and (ii) the financial
holding company reduces its ownership in the fund, if any, to less
than 25 percent of the equity of the fund within one year of
sponsoring the fund or such additional period as the Board permits).
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The final rule excludes from the scope of covered entity DPC
subsidiaries and merchant banking portfolio companies, as requested by
certain commenters. The final rule also excludes portfolio companies
held under section 4(k)(4)(I) of the BHC Act, which is an investment
authority for insurance companies that is similar to merchant banking
authority; portfolio companies held under the Small Business Investment
Act of 1956; and certain companies engaged in the business of making
public welfare investments.\92\ In general, subsidiaries held under
these authorities are temporary, and there are legal restrictions and
other limitations on the involvement of the GSIB in the operations of
these kinds of subsidiaries. Moreover, it is unlikely that the
resolution of a GSIB would cause the disorderly unwind of the QFCs of
these subsidiaries in a manner that would impair the orderly resolution
of the GSIB. Therefore, the impact of these exclusions should be
relatively small while responding to commenter concerns and reducing
burden.
---------------------------------------------------------------------------
\92\ See final rule Sec. 252.82(b).
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U.S. operations of foreign GSIBs. Finally, covered entities include
almost all U.S. operations of foreign GSIBs--their U.S. subsidiaries,
U.S. branches, and U.S. agencies that are not national banks, Federal
savings associations, Federal branches, Federal agencies, or FSIs. The
term ``global systemically important foreign banking organization''
(which this preamble shortens to ``foreign GSIB'') is defined to
include any FBO that it or the Board determines has the characteristics
of a GSIB under the methodology for identifying GSIBs adopted by the
Basel Committee on Banking Supervision (global methodology).\93\
Foreign GSIB also is defined to include a foreign banking organization
or U.S. intermediate holding company required to be formed by the
Board's Regulation YY (IHC) that the Board determines would be
designated as a GSIB under the Board's GSIB surcharge rule if the
entity were subject to the rule.\94\
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\93\ See final rule Sec. 252.87(a). The Basel Committee on
Banking Supervision (BCBS) is a committee of bank supervisory
authorities established by the central bank governors of the Group
of Ten countries in 1975. The committee's membership consists of
senior representatives of bank supervisory authorities and central
banks from Argentina, Australia, Belgium, Brazil, Canada, China,
France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan,
Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia,
Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the
United Kingdom, and the United States. In 2011, the BCBS adopted the
global methodology to identify global systemically important banking
organizations and assess their systemic importance. See ``Global
systemically important banks: Assessment methodology and the
additional loss absorbency requirement,'' (Nov. 2011), http://www.bis.org/publ/bcbs207.htm. In 2013, the BCBS published a revised
document, which provides certain revisions and clarifications to the
global methodology. See ``Global systemically important banks:
Updated assessment methodology and the higher loss absorbency
requirement,'' (July 2013), http://www.bis.org/publ/bcbs255.htm.
In November 2016, the FSB and the BCBS published an updated list
of banking organizations that are GSIBs under the assessment
methodology. The list includes the eight U.S. GSIBs and the
following 22 foreign banking organizations: Agricultural Bank of
China, Bank of China, Barclays, BNP Paribas, China Construction
Bank, Credit Suisse, Deutsche Bank, Groupe BPCE, Groupe
Cr[eacute]dit Agricole, Industrial and Commercial Bank of China
Limited, HSBC, ING Bank, Mitsubishi UFJ FG, Mizuho FG, Nordea, Royal
Bank of Scotland, Santander, Soci[eacute]t[eacute]
G[eacute]n[eacute]rale, Standard Chartered, Sumitomo Mitsui FG, UBS,
and Unicredit Group. See FSB, ``2016 update of list of global
systemically important banks'' (November 21, 2016), http://www.fsb.org/wp-content/uploads/2016-list-of-global-systemically-important-banks-G-SIBs.pdf.
\94\ See final rule Sec. 252.87(a).
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As discussed above, the Board's GSIB surcharge rule identifies the
most systemically important banking organizations on the basis of their
attributes in the categories of size, interconnectedness, cross-
jurisdictional activity, substitutability, and complexity. While the
GSIB surcharge rule applies only to U.S. bank holding companies, its
methodology is equally well-suited to evaluating the systemic
importance of foreign banking organizations. The global methodology
generally evaluates the same attributes and would identify the same set
of GSIBs as the Board's methodology. Moreover, the use of the GSIB
surcharge rule to identify both foreign GSIBs and U.S. GSIBs promotes a
level playing field between U.S. and foreign banking organizations.
The proposal would have required a top-tier foreign banking
organization that is, or controls, a covered company under the Board's
resolution plan rule (Regulation QQ) to submit by January 1 of each
calendar year a notice of whether its home country supervisor (or other
appropriate home country authority) has adopted standards consistent
with the global methodology; whether the foreign banking organization
prepares or reports the indicators used by the global methodology to
identify GSIBs; and, if it does, whether the foreign banking
organization has determined that it has the characteristics of a
GSIB.\95\ In order to reduce burden, the notice requirement of the
final rule only applies to foreign banking organizations that determine
that they have the characteristics of a GSIB.\96\ The first notice
required under this provision of the final rule is due January 1,
2018.\97\
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\95\ See proposed rule Sec. 252.87(b).
\96\ See final rule Sec. 252.87(b). Like the proposal, the
final rule requires top-tier foreign banking organizations that are
or control covered companies under Regulation QQ and that prepare or
report the indicator amounts necessary to determine whether the
organization is a GSIB to use the data to determine whether the
organization has the characteristics of a GSIB. See id. at Sec.
252.87(c).
\97\ The final rule makes clear that foreign banking
organizations that are subject to similar notice and determination
requirements under the Board's TLAC rule (12 CFR 252.153(b)(5)-
(b)(6)) may comply with the final rule by complying with the similar
requirements in the Board's TLAC rule. See id. at Sec. 252.87(d).
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As with U.S. GSIBs, the final rule's focus on those foreign banking
organizations that qualify as GSIBs is in keeping with the Dodd-Frank
Act's mandate that more stringent prudential standards be applied to
the most systemically important banking organizations.\98\ The final
rule, like the proposal, covers only the U.S. operations of foreign
GSIBs. Like the proposal, the final rule excludes section 2(h)(2)
companies \99\ and DPC branch
[[Page 42894]]
subsidiaries, which are also types of entities excluded by regulation
from being held under an IHC.\100\ To provide the same treatment for
foreign GSIBs and U.S. GSIBs, the final rule also excludes DPC
subsidiaries, merchant banking portfolio companies, portfolio companies
held under section 4(k)(4)(I) of the BHC Act, portfolio companies held
under the Small Business Investment Act of 1956, and public welfare
investments of foreign GSIBs.\101\
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\98\ 12 U.S.C. 5365(a)(1)(B).
\99\ Section 2(h)(2) of the BHC Act provides that the activity
and ownership restrictions of section 4 of the BHC Act do not apply
to shares of any company organized under the laws of a foreign
country (or to shares held by such company in any company engaged in
the same general line of business as the investor company or in a
business related to the business of the investor company) that is
principally engaged in business outside the United States if such
shares are held or acquired by a bank holding company organized
under the laws of a foreign country that is principally engaged in
the banking business outside the United States. 12 U.S.C.
1841(h)(2). As with the similar exclusion to the Board's U.S. IHC
requirement (12 CFR 252.153(b)(1)), the Board has taken into account
the nonfinancial activities and affiliations of a foreign banking
organization in permitting the exclusion for section 2(h)(2)
companies from the final rule. Cf. 79 FR 17240 (Mar. 27, 2014).
\100\ 12 CFR 252.2(j) and (x).
\101\ See final rule Sec. 252.82(b)(3).
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The final rule does not exempt U.S. branches and agencies of
foreign GSIBs or U.S. subsidiaries of foreign GSIBs that are not held
under an IHC pursuant to a Board order, as requested by certain
commenters. The exemptions by Board order were provided in the context
of another rule, and the same considerations do not apply in the
context of this final rule as these subsidiaries could impact the
resolvability of the U.S. operations of a foreign GSIB.\102\ As with
the coverage of subsidiaries of U.S. GSIBs, coverage of the U.S.
operations of foreign GSIBs will enhance the prospects for an orderly
resolution of the foreign GSIB and its U.S. operations. In particular,
covering QFCs that involve any U.S. subsidiary, U.S. branch, or U.S.
agency of a foreign GSIB will reduce the potentially disruptive
cancellation of those QFCs if the foreign GSIB or any of its
subsidiaries enters resolution, including resolution under the U.S.
Bankruptcy Code or the U.S. Special Resolution Regimes.\103\
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\102\ See 12 CFR 252.153(c)(1)-(2).
\103\ The laws and regulations imposed in non-U.S. jurisdictions
that commenters noted were similar to the requirements of the
proposed rule do not address resolution under U.S. insolvency or the
U.S. Special Resolution Regimes.
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B. Covered QFCs (Section 252.82(c) of the Final Rule)
General definition. The proposal applied to any ``covered QFC,''
generally defined as any QFC that a covered entity enters into,
executes, or otherwise becomes party to with the person or an affiliate
of the same person.\104\ Under the proposal, ``qualified financial
contract'' or ``QFC'' was defined as in section 210(c)(8)(D) of Title
II of the Dodd-Frank Act and included swaps, repo and reverse repo
transactions, securities lending and borrowing transactions, commodity
contracts, and forward agreements.\105\
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\104\ See proposed rule Sec. 252.83(a). For convenience, this
preamble generally refers to ``a covered entity's QFCs'' or ``QFCs
to which a covered entity is party'' as shorthand to encompass the
definition of ``covered QFC.''
\105\ See proposed rule Sec. 252.81. See also 12 U.S.C.
5390(c)(8)(D).
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The application of the rule's requirements to a ``covered QFC'' was
one of the most commented upon aspects of the proposal. Certain
commenters argued that the definition of QFC in Title II of the Dodd-
Frank Act was overly broad and imprecise and could include agreements
that market participants may not expect to be subject to the stay-and-
transfer provisions of the U.S. Special Resolution Regimes. More
generally, commenters argued that the proposed definition of QFC was
too broad and would capture contracts that do not present any obstacles
to an orderly resolution. Commenters urged the Board to exclude a
variety of types of QFCs from the requirements of the final rule. In
particular, a number of commenters urged the Board to exclude QFCs that
do not contain any transfer restrictions or default rights, because
these types of QFCs do not give rise to the risk that counterparties
will exercise their contractual rights in a manner that is inconsistent
with the provisions of the U.S. Special Resolution Regimes. Commenters
named several examples of contracts that fall into this category,
including cash market securities transactions, certain spot FX
transactions (including securities conversion transactions), retail
brokerage agreements, retirement/IRA account agreements, margin
agreements, options agreements, FX forward master agreements, and
delivery versus payment client agreements. Commenters contended that
these types of QFCs number in the millions at some firms and that
remediating these contracts to include the express provisions required
by the final rule would require an enormous client outreach effort that
would be extremely burdensome and costly while providing no meaningful
resolution benefits. For example, commenters pointed out that for
certain types of transaction, such as cash securities transactions, FX
spot transactions, and retail QFCs, such a requirement could require an
overhaul of existing market practice and documentation that affects
hundreds of thousands, if not millions, of transactions occurring on a
daily basis and significant education of the general market.
Commenters also urged the Board to exclude QFCs that do not contain
any default or cross-default rights but that may contain transfer
restrictions. Commenters contended that examples of these types of
agreements included investment advisory account agreements with retail
customers, which contain transfer restrictions as required by section
205(a)(2) of the Investment Advisers Act of 1940, but no direct default
or cross-default rights; underwriting agreements; \106\ and client
onboarding agreements. A few commenters provided prime brokerage or
margin loan agreements as examples of transactions that generally do
not have default or cross-default rights but may have transfer
restrictions. Another commenter also requested the exclusion of
securities market transactions that generally settle in the short term,
do not impose ongoing or continuing obligations on either party after
settlement, and do not typically include default rights.\107\ In these
cases, commenters contended that remediation of these agreements would
be burdensome with no meaningful resolution benefits.
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\106\ However, certain commenters noted that underwriting,
purchase, subscription, or placement agency agreements may contain
rights that could be construed as cross-default rights or default
rights.
\107\ In the alternative, the commenter requested that such
securities market transactions be excluded to the extent they are
cleared, processed, and settled through (or subject to the rules of)
FMUs through expansion of the proposed exemption for transactions
with central counterparties. This aspect of the comment is addressed
in the subsequent section discussing requests for expansion of the
proposed exemption for transactions with central counterparties.
---------------------------------------------------------------------------
Commenters also argued for the exclusion of a number of other types
of contracts from the definition of covered QFC in the final rule. In
particular, a number of commenters urged the Board to exclude contracts
issued in the capital markets or related to a capital market issuance,
like warrants or a certificate representing a call option, typically on
a security or a basket of securities. Although warrants issued in
capital markets may contain direct default and cross-default rights as
well as transfer restrictions, commenters argued that remediation of
outstanding warrant agreements would be difficult, if not impossible,
since remediation would require the affirmative vote of a substantial
number of separate voting groups of holders to amend the terms of the
instruments and that obtaining such consent could be expensive due to
``hold-out'' premiums. Commenters also
[[Page 42895]]
argued that since these instruments are traded in the markets, it is
not possible for an issuer to ascertain whether a particular investor
in such instruments has also entered into other QFCs with the dealer or
any of its affiliates (or vice versa) for purposes of complying with
the proposed mechanism for remediation of existing QFCs. Commenters
argued that issuers would be able to comply if the final rule's
requirements applied only on a prospective basis with respect to new
issuances, since new investors could be informed of the terms of the
warrant at the time of purchase and no after-the-fact consent would be
required, as is the case with existing outstanding warrants. Commenters
expressed the view that prospective application of the final rule's
requirements to warrants would allow time for firms to develop new
warrant agreements and warrant certificates, to engage in client
outreach efforts, and to make any appropriate public disclosures.
Commenters suggested that the requirements of the final rule should
only apply to such instruments issued after the effective date of the
final rule and that the compliance period for such new issuances be
extended to allow time to establish new issuance programs that comply
with the final rule's requirements. Other examples of contracts in this
category given by commenters include contracts with special purpose
vehicles that are multi-issuance note platforms, which commenters urged
would be difficult to remediate for similar reasons to warrants other
than on a prospective basis.
Commenters also urged the exclusion of contracts for the purchase
of commodities in the ordinary course of business (e.g., utility and
gas energy supply contracts) or physical delivery commodity contracts
more broadly.\108\ In general, commenters argued that exempting these
contracts would not increase systemic risk but would help ensure the
smooth operation of utilities and the physical commodities
markets.\109\ Commenters indicated that failure to make commodity
deliveries on time can result in the accrual of damages and penalties
beyond the accrual of interest (e.g., demurrage and other fines in
shipping) and that counterparties may not be able to obtain appropriate
compensation for amendment of default rights due to the difficulty of
pricing the risk associated with an operational failure due to the
failure to deliver a commodity on time. Commenters also contended that
agreements with power operators governed by regulatory tariffs would be
difficult, if not impossible, to remediate.\110\
---------------------------------------------------------------------------
\108\ For example, some commenters urged the exclusion of all
contracts requiring physical delivery between commercial entities in
the course of regulatory business such as (i) contracts subject to a
Federal Energy Regulatory Commission-filed tariff; (ii) contracts
that are traded in markets overseen by independent system operators
or regional transmission operators; (iii) retail electric contracts;
(iv) contracts for storage or transportation of commodities; (v)
contracts for financial services with regulated financial entities
(e.g., brokerage agreements and futures account agreements); and
(vi) public utility contracts.
\109\ One commenter also argued that utility and gas supply
contracts are covered sufficiently in section 366 of the U.S.
Bankruptcy Code. This section of the U.S. Bankruptcy Code places
restrictions on the ability of a utility to ``alter, refuse, or
discontinue service to, or discriminate against, the trustee or the
debtor solely on the basis of the commencement of a case under [the
U.S. Bankruptcy Code] or that a debt owed by the debtor to such
utility for service rendered before the order for relief was not
paid when due.'' 11 U.S.C. 366. The purpose and effect of section
252.84 of the final rule and section 366 of the U.S. Bankruptcy Code
are different and therefore do not serve as substitutes. Section 366
of the U.S. Bankruptcy Code does not address cross-defaults or
provide additional clarity regarding the application of the U.S.
Special Resolution Regimes. Similarly, section 252.84 of the final
rule does not prevent a covered entity from entering into a covered
QFC that allows the counterparty to exercise default rights once a
covered entity that is a direct party either enters bankruptcy or
fails to pay or perform under the QFC.
\110\ One commenter also requested exclusion of overnight
transactions, particularly overnight repurchase agreements, arguing
that such transactions present little risk of creating negative
liquidity effects and that an express exclusion for such
transactions may increase the likelihood that such contracts would
remain viable funding sources in times of liquidity stress. Although
the final rule does not exempt overnight repo transactions, the
final rule may have limited if any effect on such transactions. As
described below, the final rule provides a number of exemptions that
may apply to overnight repo and similar transactions. Moreover, the
restrictions on default rights in section 252.84 of the final rule
do not apply to any right under a contract that allows a party to
terminate the contract on demand or at its option at a specified
time, or from time to time, without the need to show cause. See
final rule Sec. 252.81 (defining ``default right''). Therefore,
section 252.84 does not restrict the ability of QFCs, including
overnight repos, to terminate at the end of the term of the
contract.
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The final rule applies to any ``covered QFC,'' which generally is
defined as any ``in-scope QFC'' that a covered entity enters into,
executes, or to which the covered entity otherwise becomes a
party.\111\ As under the proposal, ``qualified financial contract'' or
``QFC'' is defined in the final rule as in section 210(c)(8)(D) of
Title II of the Dodd-Frank Act and includes swaps, repo and reverse
repo transactions, securities lending and borrowing transactions,
commodity contracts, and forward agreements.\112\ Parties that enter
into contracts with covered entities have been potentially subject to
the stay-and-transfer provisions of Title II of the Dodd-Frank Act
since its enactment. Consistent with Title II, the final rule does not
exempt QFCs involving physical commodities. However, as explained
below, the final rule responds to concerns regarding the smooth
operation of physical commodities end users and markets by allowing
counterparties to terminate QFCs based on the failure to pay or
perform.
---------------------------------------------------------------------------
\111\ See final rule Sec. 252.82(c).
\112\ See final rule Sec. 252.81. See also 12 U.S.C.
5390(c)(8)(D).
---------------------------------------------------------------------------
In response to concerns raised by commenters, the final rule
exempts QFCs that have no transfer restrictions or default rights, as
these QFCs have no provisions that the rule is intended to address. The
final rule effects this exemption by limiting the scope of QFCs
potentially subject to the rule to those QFCs that explicitly restrict
the transfer of a QFC from a covered entity or explicitly provide
default rights that may be exercised against a covered entity (in-scope
QFCs).\113\ This change addresses a major concern raised by commenters
regarding the overbreadth of the definition of ``covered QFC'' in the
proposal. The change also mitigates the burden of complying with the
proposed rule without undermining its purpose by not requiring covered
entities to conform contracts that do not contain the types of default
rights and transfer restrictions that the final rule is intended to
address. The Board has declined, however, to exclude QFCs that have
transfer restrictions (but no default rights or cross-default rights),
as requested by certain commenters, as such QFCs would have provisions
(i.e., transfer restrictions) that are subject to the requirements of
the final rule and could otherwise impede the orderly resolution of a
covered entity or its affiliate.
---------------------------------------------------------------------------
\113\ See final rule Sec. 252.82(d).
---------------------------------------------------------------------------
The final rule provides that a covered entity is not required to
conform certain investment advisory contracts described by commenters
(i.e., investment advisory contracts with retail advisory customers
\114\ of the covered entity that only contain the transfer restrictions
required by section 205(a) of the Investment Advisers Act). The final
rule also exempts existing warrants evidencing a right to subscribe or
to
[[Page 42896]]
otherwise acquire a security of a covered entity or its affiliate.\115\
The Board has determined to exclude these types of agreements since
there is persuasive evidence that these types of contracts would be
burdensome to conform and that it is unlikely that excluding such
contracts from the requirements of the final rule would impair the
orderly resolution of a GSIB.\116\
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\114\ See final rule Sec. 252.88(c)(1). The final rule defines
retail customer or counterparty by reference to the Board's
Regulation WW. See 12 CFR 249.3; see also FR 2052a, https://www.federalreserve.gov/reportforms/forms/FR_2052a20161231_f.pdf.
Covered entities should be familiar with this definition and its
application.
\115\ See final rule Sec. 252.88(c)(2). Warrants issued after
the effective date of the final rule are not excluded from the
requirements of the final rule.
\116\ These exemptions are not interpretations of the definition
of QFC.
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The final rule also provides the Board with authority to exempt one
or more covered entities from conforming certain contracts or types of
contracts to the final rule after considering, in addition to any other
factor the Board deems relevant, the burden the exemption would relieve
and the potential impact of the exemption on the resolvability of the
covered entity or its affiliates.\117\ Covered entities that request
that the Board exempt additional contracts from the final rule should
be prepared to provide information in support of their requests. The
Board expects to consult as appropriate with the FDIC and OCC during
its consideration of any such request.
---------------------------------------------------------------------------
\117\ See final rule Sec. 252.88(d).
---------------------------------------------------------------------------
Definition of counterparty. As noted above, the proposal applied to
any ``covered QFC,'' generally defined as a QFC that a covered entity
enters after the effective date and a QFC entered earlier, but only if
the covered entity or its affiliate enters a new QFC with the same
person or an affiliate of the same person.\118\ ``Affiliate'' in the
proposal was defined in the same manner as under the BHC Act to mean
any company that controls, is controlled by, or is under common control
with another company.\119\ As noted above, ``control'' under the BHC
Act means the power to vote 25 percent or more of any class of voting
securities; control in any manner the election of a majority of the
directors or trustees; or exercise of a controlling influence over the
management or policies.\120\
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\118\ See proposed rule Sec. Sec. 252.83(a), 225.84(a).
\119\ See 12 CFR 252.2 (defining ``affiliate'').
\120\ See 12 U.S.C. 1841(k).
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Commenters argued that requiring remediation of existing QFCs of a
person if the GSIB entered into a new QFC with an affiliate of the
person would make compliance with the proposed rule overly
burdensome.\121\ These arguments were similar to commenters' arguments
regarding the definition of ``subsidiary'' of a covered entity, which
were discussed above. Commenters pointed out that this requirement
would demand that the GSIB track each counterparty's organizational
structure by relying on information provided by counterparties, which
would subject counterparties to enhanced tracking and reporting
burdens. Commenters requested that the phrase ``or affiliate of the
same person'' be deleted from the definition of covered QFC and argued
that such a modification would not undermine the ultimate goals of the
rule since existing QFCs with the counterparty's affiliate would still
have be remediated if the covered entity or its affiliate enters into a
new QFC with that counterparty affiliate. In the alternative,
commenters argued that an affiliate of a counterparty be established by
reference to financial consolidation principles rather than BHC Act
control, since counterparties may not be familiar with BHC Act control.
Commenters argued that many counterparties are not regulated bank
holding companies and would be unfamiliar with BHC Act control. Certain
commenters also argued that a new QFC with one fund in a fund family
should not result in other funds in the fund family being required to
conform their pre-existing QFCs with the covered entity or an
affiliate.
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\121\ One commenter believed that the burden of conforming
contracts with all affiliates of a counterparty would be too great,
whether defined in terms of BHC Act control or financial
consolidation principles, even though the burden would be reduced by
definition in terms of financial consolidation principles.
---------------------------------------------------------------------------
The final rule's definition of ``covered QFC'' has been modified to
address the concerns raised by commenters. In particular, the final
rule provides that a covered QFC includes a QFC that the covered entity
entered, executed, or otherwise became a party to before January 1,
2019, if the covered entity or any affiliate that is a covered entity
or excluded bank also enters, executes, or otherwise becomes a party to
a QFC with the same person or a consolidated affiliate of the same
person on or after January 1, 2019.\122\ The final rule defines
``consolidated affiliate'' by reference to financial consolidation
principles.\123\ As commenters pointed out, counterparties will already
track and monitor financially consolidated affiliates. Moreover,
exposures to a non-consolidated affiliate may be captured as a separate
counterparty (e.g., when the non-consolidated affiliate enters a new
QFC with the covered entity). As a consequence, modifying the coverage
of affiliates in this manner addresses concerns raised by commenters
regarding burden while still providing sufficient incentives to
remediate existing covered QFCs.
---------------------------------------------------------------------------
\122\ See final rule Sec. 252.82(c).
\123\ See final rule Sec. 252.81.
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The definition of ``covered QFC'' is intended to limit the
restrictions of the final rule to those financial transactions whose
disorderly unwind has substantial potential to frustrate the orderly
resolution of a GSIB, as discussed above. By adopting the Dodd-Frank
Act's definition of QFC, with the modifications described above, the
final rule generally extends stay-and-transfer protections to the same
types of transactions as Title II of the Dodd-Frank Act. In this way,
the final rule enhances the prospects for an orderly resolution in
bankruptcy and under the U.S. Special Resolution Regimes.
Exclusion of cleared QFCs. The proposal excluded from the
definition of ``covered QFC'' all QFCs that are cleared through a
central counterparty (CCP).\124\ Commenters generally expressed support
for this exclusion, but some commenters requested that the Board
broaden this exclusion in the final rule. In particular, a number of
commenters urged the Board to exclude the ``client-facing leg'' of a
cleared swap where a clearing member faces a CCP on one leg of the
transaction and faces the client on an otherwise identical offsetting
transaction.\125\ One commenter
[[Page 42897]]
requested the Board confirm its understanding that ``FCM agreements,''
which the commenter defined as futures and cleared swaps agreements
with a futures commission merchant, are excluded because FCM agreements
``are only QFCs to the extent that they relate to futures and swaps
and, since futures and cleared swaps are excluded, the FCM Agreements
are also excluded.'' \126\ The commenter requested, in the alternative,
that the final rule expressly exclude such agreements.
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\124\ See proposed rule Sec. 252.88(a).
\125\ Commenters argued that, in the European-style principal-
to-principal clearing model, the clearing member faces the CCP on
one swap (the ``CCP-facing leg''), and the clearing member,
frequently a covered entity, faces the client on an otherwise
identical, offsetting swap (the ``client-facing leg''). Under the
proposed rule, only the CCP-facing leg of the transaction was
excluded, even though the client-facing leg is necessary to the
mechanics of clearing and is only entered into by the clearing
member to effectuate the cleared transaction. Commenters argued that
the proposed rule thus treated two pieces of the same transaction
differently, which could result in an imbalance in insolvency or
resolution and that the possibility of such an imbalance for the
clearing member could expose the clearing member to unnecessary and
undesired market risk. Commenters urged the Board to adopt the same
approach taken under Section 2 of the Universal Protocol, which
allows the client-facing leg of the cleared swap with the clearing
member that is a covered entity to be closed out substantially
contemporaneously with the CCP-facing leg in the event the CCP were
to take action to close out the CCP-facing leg.
Some commenters requested clarification that transactions
between a covered entity client and its clearing member (as opposed
to transactions where the covered entity is the clearing member)
would be subject to the rule's requirements, since this would be
consistent with the Universal Protocol. As explained in this
section, the exemption in the final rule regarding CCPs does not
depend on whether the covered entity is a clearing member or a
client. A covered QFC--generally a QFC to which a covered entity is
a party--is exempted from the requirements of the final rule if a
CCP is also a party.
\126\ Letter to Robert deV. Frierson, Secretary, Board of
Governors of the Federal Reserve System, from James M. Cain,
Sutherland Asbill & Brennan LLP, writing on behalf of the eleven
Federal Home Loan Banks, at 2 (Aug. 5, 2016).
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A few commenters requested that the Board modify the definition of
``central counterparty,'' which was defined to mean ``a counterparty
(for example, a clearing house) that facilitates trades between
counterparties in one or more financial markets by either guaranteeing
trades or novating trades'' in the proposal.\127\ These commenters
argued that a CCP does far more than ``facilitate'' or ``guarantee''
trades and that a CCP ``interposes itself between counterparties to
contacts traded in one or more financial markets, becoming the buyer to
every seller and the seller to every buyer and thereby ensuring the
performance of open contracts.'' \128\ As an alternative definition of
CCP, these commenters suggested the final rule should define central
counterparty to mean: ``an entity (for example, a clearinghouse or
similar facility, system, or organization) that, with respect to an
agreement, contract, or transaction: (i) Enables each party to the
agreement contract, or transaction to substitute, through novation or
otherwise, the credit of the CCP for the credit of the parties; and
(ii) arranges or provides, on a multilateral basis, for the settlement
or netting of obligations resulting from such agreements, contracts, or
transactions executed by participants in the CCP.'' \129\
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\127\ 12 CFR 217.2.
\128\ Letter to Robert deV. Frierson, Secretary, Board of
Governors of the Federal Reserve System, from Walt L. Lukken,
President and CEO, Futures Industry Association, at 8-9 (Aug. 5,
2016) (citing Principles of Financial Market Infrastructures (Apr.
2012), published by the Committee on Payment and Settlement Systems
and the International Organization of Securities Commissions, at 9).
\129\ Id. at 9.
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Commenters also urged the Board to exclude from the requirements of
the final rule all QFCs that are cleared, processed, or settled through
the facilities of an FMU, as defined in section 803(6) of the Dodd-
Frank Act,\130\ or that are entered into subject to the rules of an
FMU.\131\ For example, commenters argued that QFCs with FMUs, such as
the provision of an extension of credit by a central securities
depository (CSD) to a covered entity that is a member of the CSD in
connection with the settlement of securities transactions, should be
excluded from the requirements of the final rule. Commenters contended
that, similar to CCPs, the relationship between a covered entity and
FMU is governed by the rules of the FMU and that there are no market
alternatives to continuing to transact with FMUs. Commenters argued
that FMUs generally should be excluded for the same reasons as CCPs and
that a broader exemption to cover FMUs would serve to mitigate the
systemic risk of a GSIB in distress, an underlying objective of the
rule's requirements. Commenters contended that such an exclusion would
be consistent with the treatment of FMUs under U.K. regulations and
German law. Some commenters also requested that related or underlying
agreements to CCP-cleared QFCs and QFCs entered into with other FMUs
also be excluded, since such agreements ``form an integrated whole with
[those] QFCs'' and such an exemption would facilitate the continued
expansion of the clearing and settlement framework and the benefits of
such a framework.\132\ One commenter urged that the final rule should
not in any manner restrict an FMU's ability to close out a defaulting
clearing member's portfolio, including potential liquidation of cleared
contracts.
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\130\ 12 U.S.C. 5462(6). In general, Title VIII of the Dodd-
Frank Act defines ``financial market utility'' to mean any person
that manages or operates a multilateral system for the purpose of
transferring, clearing, or settling payments, securities, or other
financial transactions among financial institutions or between
financial institutions and the person. Id.
\131\ As discussed above, one commenter who recommended an
exclusion of securities market transactions that generally settle in
the short term, do not impose ongoing or continuing obligations on
either party after settlement, and do not typically include the
default rights targeted by this rule, requested this treatment in
the alternative.
\132\ Letter to Robert deV. Frierson, Secretary, Board of
Governors of the Federal Reserve System, from Larry E. Thompson,
Vice Chairman and General Counsel, The Depository Trust & Clearing
Corporation, at 6 (Aug. 5, 2016).
---------------------------------------------------------------------------
The issues that the final rule is intended to address with respect
to non-cleared QFCs may also exist in the context of centrally cleared
QFCs. However, clearing through a CCP provides unique benefits to the
financial system while presenting unique issues related to the
cancellation of cleared contracts. Accordingly, the Board continues to
believe it is appropriate to exclude centrally cleared QFCs, in light
of differences between cleared and non-cleared QFCs with respect to
contractual arrangements, counterparty credit risk, default management,
and supervision. The Board has not extended the exclusion for CCPs to
the client-facing leg of a cleared transaction because bilateral trades
between a GSIB and a non-CCP counterparty are the types of transactions
that the final rule intends to address and because nothing in the final
rule would prohibit a covered entity clearing member and a client from
agreeing to terminate or novate a trade to balance the clearing
member's exposure. The final rule continues to define central
counterparty as a counterparty that facilitates trades between
counterparties in one or more financial markets by either guaranteeing
trades or novating trades, which is a broad definition that should be
familiar to market participants as it is used in the regulatory capital
rules.\133\
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\133\ See final rule Sec. 252.81. See also 12 CFR 217.2.
---------------------------------------------------------------------------
The final rule also makes clear that, if one or more FMUs are the
only counterparties to a covered QFC, the covered entity is not
required to conform the covered QFC to the final rule.\134\ Therefore,
an FMU's default rights and transfer restrictions under the covered QFC
are not affected by the final rule. However, this exclusion would not
include a covered QFC with a non-FMU counterparty, even if the QFC is
settled by an FMU or if the FMU is a party to such QFC, because the
final rule is intended to address default rights of non-FMU parties.
For example, if two covered entities engage in a bilateral QFC that is
facilitated by an FMU and, in the course of this facilitation each
covered entity maintains a QFC solely with the FMU, then the final rule
would not apply to each QFC between the FMU and each covered entity but
the requirements of the final rule would apply to the bilateral QFC
between the two covered entities. This approach ensures that QFCs that
are directly with FMUs are treated in a manner similar to transactions
between covered entities and CCPs, but also ensures that QFCs conducted
by covered entities that are related to the direct QFC with the FMU
[[Page 42898]]
remain subject to the final rule's requirements.
---------------------------------------------------------------------------
\134\ See final rule Sec. 252.88(a)(2). In response to
commenters, the final rule uses the definition of FMU in Title VIII
of the Dodd-Frank Act and may apply, for purposes of the final rule,
to entities regardless of jurisdiction. The definition of FMU in the
final rule includes a broader set of entities, in addition to CCPs.
However, the definition in the final rule does not include
depository institutions that are engaged in carrying out banking-
related activities, including providing custodial services for tri-
party repurchase agreements. The definition also explicitly excludes
certain types of entities (e.g., registered futures associations,
swap data repositories) and other types of entities that perform
certain functions for or related to FMUs (e.g., futures commission
merchants).
---------------------------------------------------------------------------
The final rule does not explicitly exclude futures and cleared
swaps agreements with a futures commission merchant, as requested by a
commenter. The nature and scope of the requested exclusion is unclear,
and, therefore, it is unclear whether the exclusion would be necessary,
on the one hand, or overbroad, on the other hand. However, the final
rule makes a number of other clarifications and exemptions that may
help address the commenter's concern regarding FCM agreements.
Exclusion of certain QFCs under multi-branch master agreements of
foreign banking organizations. To avoid imposing unnecessary
restrictions on QFCs that are not closely connected to the United
States, the proposal excluded from the definition of ``covered QFC''
certain QFCs of foreign GSIBs that lack a close connection to the
foreign GSIB's U.S. operations.\135\ The proposed definition of ``QFC''
included master agreements that apply to QFCs.\136\ Master agreements
are contracts that contain general terms that the parties wish to apply
to multiple transactions between them; having executed the master
agreement, the parties can then include those terms in future contracts
through reference to the master agreement. Moreover, the Dodd-Frank
Act's definition of ``qualified financial contract,'' which the
proposal would adopt, treats master agreements for QFCs together with
all supplements to the master agreement (including underlying
transactions) as a single QFC.\137\
---------------------------------------------------------------------------
\135\ See proposed rule Sec. 252.86.
\136\ See proposed rule Sec. 252.81.
\137\ 12 U.S.C. 5390(c)(8)(D)(viii); see also 12 U.S.C.
1821(e)(8)(D)(vii); 109 H. Rpt. 31, Prt. 1 (April 8, 2005)
(explaining that a ``master agreement for one or more securities
contracts, commodity contracts, forward contracts, repurchase
agreements or swap agreements will be treated as a single QFC under
the FDIA or the [Federal Credit Union Act] (but only with respect to
the underlying agreements are themselves QFCs)'').
---------------------------------------------------------------------------
Foreign GSIBs have master agreements that permit transactions to be
entered into both at a U.S. branch or U.S. agency of the foreign GSIB
and at a non-U.S. location of the foreign GSIB (such as a foreign
branch). Notwithstanding the proposal's general treatment of a master
agreement and all QFCs thereunder as a single QFC, the proposal would
have excluded QFCs under such a ``multi-branch master agreement'' that
are not booked at a covered entity and for which no payment or delivery
may be made at a covered entity.\138\ Under the proposal, a multi-
branch master agreement was a covered QFC with respect to QFC
transactions that are booked at a covered entity or for which payment
or delivery may be made at a covered entity.
---------------------------------------------------------------------------
\138\ See proposed rule Sec. 252.86(a). With respect to a U.S.
branch or U.S. agency of a foreign GSIB, a multi-branch master
agreement that is a covered QFC solely because the master agreement
permits agreements or transactions that are QFCs to be entered into
at one or more U.S. branches or U.S. agencies of the foreign GSIB
was considered a covered QFC for purposes of the proposal only with
respect to such agreements or transactions booked at such U.S.
branches and U.S. agencies or for which a payment or delivery may be
made at such U.S. branches or U.S. agencies.
---------------------------------------------------------------------------
Commenters expressed support for this exclusion, but requested that
the requirement exclude from the definition of covered QFC those
transactions under master agreements where payment and deliveries may
be made by or to the U.S. branch or agency so long as the transactions
or assets are not booked in the U.S. branch or agency. These commenters
argued that the ability to make payments or delivery alone does not
make a QFC sufficiently closely connected to the United States to raise
the concerns about resolution that the rule is intended to address.
Commenters also argued that the requirement to include new contractual
terms in a QFC where payment or delivery may occur in the United States
would require foreign GSIBs to amend many additional QFCs booked
abroad, many of which must also be amended to comply with contractual
stay requirements of the foreign GSIBs' home country regulatory
regimes. Commenters argued that amending such QFCs under multi-branch
master agreements that are not booked in the United States would
require some foreign GSIBs to amend thousands of contracts at
significant cost and would impose a disproportionate burden on foreign
GSIBs as compared to U.S. GSIBs. These commenters argued this would
impose a significant burden on non-U.S. covered entities with no
benefit to U.S. financial stability, as these QFCs would not be
expected to be subject to a U.S. resolution regime.
One commenter also recommended that multi-branch master agreements
be treated as a single QFC, rather than requiring the application of
different requirements to different transactions thereunder, so as to
align the rule's requirements with current industry-standard
documentation and to avoid additional implementation hurdles and costs.
The commenter recommended that the entirety of a multi-branch master
agreement and underlying transactions be a covered QFC if a new QFC
with the counterparty or its consolidated affiliates is booked to the
U.S. branch or agency after the compliance date or if a new QFC is
entered into with an affiliate of the U.S. branch or agency that is
also subject to the requirements.
The final rule has been modified from the proposal to address the
concerns raised by commenters. In particular, the final rule provides
that, with respect to a U.S. branch or U.S. agency of a foreign GSIB, a
foreign GSIB multi-branch master agreement that is a covered QFC solely
because the master agreement permits agreements or transactions that
are QFCs to be entered into at one or more U.S. branches or U.S.
agencies of the foreign GSIB will be considered a covered QFC for
purposes of this subpart only with respect to such agreements or
transactions booked at such U.S. branches and U.S. agencies.\139\ The
final rule does not provide that such an agreement will be a covered
QFC solely because payment or delivery may be made at such U.S. branch
or agency. These modifications will avoid imposing unnecessary
restrictions on QFCs that are not closely connected to the United
States and will mitigate burden and reduce costs on foreign GSIBs
without undermining the purpose of the final rule. The purpose of this
exclusion is to help ensure that, where a foreign GSIB has a multi-
branch master agreement, the foreign GSIB will only have to conform
those QFCs entered into under the multi-branch master agreement that
could have the most direct effect on the covered U.S. branch or U.S.
agency of the foreign GSIB and that could therefore have the most
direct effect on the resolution of the foreign GSIB and the financial
stability of the United States.
---------------------------------------------------------------------------
\139\ See final rule Sec. 252.86.
---------------------------------------------------------------------------
The final rule does not, as requested by one commenter, deem the
entirety of a multi-branch master agreement to be a covered QFC if a
new QFC with the counterparty (or its consolidated affiliate) is booked
to the covered entity or its affiliate. Many commenters supported
excluding transactions from multi-branch master netting agreements that
are not closely connected to the United States. In contrast to the
proposal and these comments, the modification requested by this
commenter would require transactions that are not booked in the United
States or otherwise connected to the United States to be conformed to
the requirements of the final rule. The commenter's concerns regarding
costs associated with potentially breaking netting sets may nonetheless
be addressed through adherence to the Universal Protocol or the U.S.
Protocol, which are discussed below.
[[Page 42899]]
QFCs with Central Banks and Sovereign Entities. The proposal
included covered QFCs with sovereign entities and central banks,
consistent with Title II of the Dodd-Frank Act and the FDI Act.
Commenters urged the Board to exclude QFCs with central bank and
sovereign counterparties from the final rule. Commenters argued that
sovereign entities might not be willing to agree to limitations on
their QFC default rights and noted that other countries' measures, such
as those of the United Kingdom and Germany, consistent with their
governing laws, exclude central banks and sovereign entities.
Commenters contended that central banks and sovereign entities are
sensitive to financial stability concerns and resolvability goals, thus
reducing the concern that they would exercise default rights in a way
that would undermine resolvability of a GSIB or financial stability.
Commenters indicated it was unclear whether central banks or sovereign
entities would be permitted under applicable statutes to enter into
QFCs with limited default rights, but did not provide specific examples
of such statutes.\140\ Commenters further noted that these entities did
not participate in the development of the Universal Protocol and that
the Universal Protocol does not provide a viable mechanism for
compliance with the final rule by these entities.
---------------------------------------------------------------------------
\140\ These commenters argued that, to the extent central banks
and sovereign entities are unable or unwilling to agree to
limitations on their QFC default rights, application of the rule's
requirements to QFCs with these entities creates a significant
disincentive for these entities to enter into QFCs with covered
entities, resulting in the loss of valuable counterparties in a way
that will hinder market liquidity and covered entity risk
management.
---------------------------------------------------------------------------
The Board continues to believe that covering QFCs with sovereigns
and central banks under the final rule is an important requirement and
has not modified the final rule to address the requests made by
commenters. Excluding QFCs with sovereigns and central banks would be
inconsistent with Title II of the Dodd-Frank Act and the FDI Act.
Moreover, the mass termination of such QFCs has the potential to
undermine the resolution of a GSIB and the financial stability of the
United States. The final rule provides covered entities two years to
conform covered QFCs with central banks and sovereigns (as well as
certain other counterparties, as discussed below). This additional time
should provide covered entities sufficient time to develop separate
conformance mechanisms for sovereigns and central banks, if necessary.
C. Definition of ``Default Right'' (Section 252.81 of the Final Rule)
As discussed above, a party to a QFC generally has a number of
rights that it can exercise if its counterparty defaults on the QFC by
failing to meet certain contractual obligations. These rights are
generally, but not always, contractual in nature. One common default
right is a setoff right: The right to reduce the total amount that the
non-defaulting party must pay by the amount that its defaulting
counterparty owes. A second common default right is the right to
liquidate pledged collateral and use the proceeds to pay the defaulting
party's net obligation to the non-defaulting party. Other common rights
include the ability to suspend or delay the non-defaulting party's
performance under the contract or to accelerate the obligations of the
defaulting party. Finally, the non-defaulting party typically has the
right to terminate the QFC, meaning that the parties would not make
payments that would have been required under the QFC in the future. The
phrase ``default right'' in the proposed rule was broadly defined to
include these common rights as well as ``any similar rights.'' \141\
Additionally, the definition included all such rights regardless of
source, including rights existing under contract, statute, or common
law.
---------------------------------------------------------------------------
\141\ See proposed rule Sec. 252.81.
---------------------------------------------------------------------------
However, the proposed definition of default right excluded two
rights that are typically associated with the business-as-usual
functioning of a QFC. First, same-day netting that occurs during the
life of the QFC in order to reduce the number and amount of payments
each party owes the other was excluded from the definition of ``default
right.'' \142\ Second, contractual margin requirements that arise
solely from the change in the value of the collateral or the amount of
an economic exposure were also excluded from the definition.\143\ The
reason for these exclusions was to leave such rights unaffected by the
proposed rule. The proposal's preamble explained that such exclusions
were appropriate because the proposal was intended to improve
resolvability by addressing default rights that could disrupt an
orderly resolution, not to interrupt the parties' business-as-usual
interactions under a QFC.
---------------------------------------------------------------------------
\142\ See id.
\143\ See id.
---------------------------------------------------------------------------
However, certain QFCs are also commonly subject to rights that
would increase the amount of collateral or margin that the defaulting
party (or a guarantor) must provide upon an event of default. The
financial impact of such default rights on a covered entity could be
similar to the impact of the liquidation and acceleration rights
discussed above. Therefore, the proposed definition of ``default
right'' included such rights (with the exception discussed in the
previous paragraph for margin requirements based solely on the value of
collateral or the amount of an economic exposure).\144\
---------------------------------------------------------------------------
\144\ See id.
---------------------------------------------------------------------------
Finally, contractual rights to terminate without the need to show
cause, including rights to terminate on demand and rights to terminate
at contractually specified intervals, were excluded from the definition
of ``default right'' under the proposal for purposes of the proposed
rule's restrictions on cross-default rights.\145\ This exclusion was
consistent with the proposal's objective of restricting only default
rights that are related, directly or indirectly, to the entry into
resolution of an affiliate of the covered entity, while leaving other
default rights unrestricted.
---------------------------------------------------------------------------
\145\ See proposed rule Sec. Sec. 252.81, 252.84.
---------------------------------------------------------------------------
Commenters expressed support for a number of aspects of the
definition of default rights. For example, a number of commenters
supported the proposed exclusion from the definition of ``default
right'' of contractual rights to terminate without the need to show
cause, noting that such rights exist for a variety of reasons and that
reliance on these rights is unlikely to result in a fire sale of assets
during a GSIB resolution. At least one commenter requested that this
exclusion be expanded to include force majeure events. Commenters also
expressed support for the exclusion for what commenters referred to as
``business-as-usual'' payments associated with a QFC. However, these
commenters requested clarification that certain ``business-as-usual''
actions would not be included in the definition of default right, such
as payment netting, posting and return of collateral, procedures for
the substitution of collateral and modification to the terms of the
QFC, and also requested clarification that the definition of ``default
right'' would not include off-setting transactions to third parties by
the non-defaulting counterparty. One commenter urged that, if the
Board's goal is to provide that a party cannot enforce a provision that
requires more margin because of a credit downgrade but may demand more
margin for market price changes, the rule should state so explicitly.
Another commenter
[[Page 42900]]
expressed concern that the definition of default right in the proposal
would permit a defaulting covered entity to demand collateral from its
QFC counterparty as margin due to a market price change, but would not
allow the non-covered entity to demand collateral from the covered
entity.
The final rule retains the same definition of ``default right'' as
that of the proposal.\146\ The Board believes that the definition of
default right is sufficiently clear and that additional modifications
are not needed to address the concerns raised by commenters. The final
rule does not adopt a particular exclusion for force majeure events, as
requested by certain commenters, as it is not clear--without reference
to particular contractual provisions--what this term would encompass.
Moreover, it should be clear that events typically considered to be
captured by force majeure clauses (e.g., natural disasters) would not
be related, directly or indirectly, to the resolution of an
affiliate.\147\
---------------------------------------------------------------------------
\146\ See final rule Sec. 252.81.
\147\ See final rule Sec. 252.84(b).
---------------------------------------------------------------------------
``Business-as-usual'' rights regarding changes in collateral or
margin would not be included within the definition of default right to
the extent that the right or operation of a contractual provision
arises solely from either a change in the value of collateral or margin
or a change in the amount of an economic exposure. In response to
commenters' requests for clarification, this exception includes changes
in margin due to changes in market price, but does not include changes
due to counterparty credit risk (e.g., credit rating downgrades).
Therefore, the right of either party to a covered QFC to require margin
due to changes in market price would be unaffected by the definition of
default right. Moreover, default rights that arise before a covered
entity or its affiliate enter resolution and that would not be affected
by the stay-and-transfer provisions of the U.S. Special Resolution
Regimes also would not be affected.
Regarding transactions with third parties, the final rule, like the
proposal, does not require covered entities to address default rights
in QFCs solely between parties that are not covered entities (e.g.,
off-setting transactions to third parties by the non-defaulting
counterparty, to the extent none are covered entities).
D. Required Contractual Provisions Related to the U.S. Special
Resolution Regimes (Section 252.83 of the Final Rule)
The proposed rule generally would have required a covered QFC to
explicitly provide both (a) that the transfer of the QFC (and any
interest or obligation in or under it and any property securing it)
from the covered entity to a transferee would be effective to the same
extent as it would be under the U.S. Special Resolution Regimes if the
covered QFC were governed by the laws of the United States or of a
state of the United States and (b) that default rights with respect to
the covered QFC that could be exercised against a covered entity could
be exercised to no greater extent than they could be exercised under
the U.S. Special Resolution Regimes if the covered QFC were governed by
the laws of the United States or of a state of the United States.\148\
The final rule contains these same provisions.\149\
---------------------------------------------------------------------------
\148\ See proposed rule Sec. 252.83(b).
\149\ See final rule Sec. 252.83(c).
---------------------------------------------------------------------------
A number of commenters noted that the wording of these requirements
in proposed section 252.83(b) was confusing and could be read to be
inconsistent with the intent of the section. In response to comments,
the final rule makes clearer that the substantive restrictions apply
only in the event the covered entity (or, in the case of the
requirement regarding default rights, its affiliate) becomes subject to
a proceeding under a U.S. Special Resolution Regime.\150\
---------------------------------------------------------------------------
\150\ See id.
---------------------------------------------------------------------------
A number of commenters argued that QFCs should be exempt from the
requirements of proposed section 252.83 if the QFC is governed by U.S.
law. An example of such a QFC provided by commenters includes the
standard form repurchase and securities lending agreement published by
the Securities Industry and Financial Markets Association. These
commenters argued that counterparties to such agreements are already
required to observe the stay-and-transfer provisions of the FDI Act and
Title II of the Dodd-Frank Act, as mandatory provisions of U.S. federal
law, and that requiring an amendment of these types of QFCs to include
the express provisions required under section 252.83 would be redundant
and would not provide any material resolution benefit, but would
significantly increase the remediation burden on covered entities.
Other commenters proposed a three-prong test of ``nexus with the
United States'' for purposes of recognizing an exclusion from the
express acknowledgment of the requirements of proposed section 252.83.
In particular, these commenters argued that the presence of two
factors, in addition to the contract being governed by U.S law, would
provide greater certainty that courts would apply the stay-and-transfer
provisions of the FDI Act and Title II of the Dodd-Frank Act: (1) If a
contract is entered into between entities organized in the United
States; and (2) to the extent the GSIB's obligations under the QFC are
collateralized, if the collateral is held with a U.S. custodian or
depository pursuant to an account agreement governed by U.S. law.\151\
Other commenters contended that only whether the contract is under U.S.
law, and not the location of the counterparty or the collateral, is
relevant to the analysis of whether the FDI Act and the Dodd-Frank Act
would govern the contract. Commenters also requested that if the first
additional factor (i.e., that the QFC be entered into between entities
organized in the United States) were to be included within the
exception, it should be broadened to include counterparties that have
principal places of business or that are otherwise domiciled in the
United States.
---------------------------------------------------------------------------
\151\ These commenters noted that it would be unlikely that any
court interpreting a QFC governed by U.S. law could have a
reasonable basis for disregarding the stay-and-transfer provisions
of the FDI Act or Title II of the Dodd-Frank Act.
---------------------------------------------------------------------------
The requirements of the final rule seek to provide certainty that
all covered QFCs would be treated the same way in the context of a
resolution of a covered entity under the Dodd-Frank Act or the FDI Act.
The stay-and-transfer provisions of the U.S. Special Resolution Regimes
should be enforced with respect to all contracts of any U.S. GSIB
entity that enters resolution under a U.S. Special Resolution Regime,
as well as all transactions of the subsidiaries of such an entity.
Nonetheless, it is possible that a court in a foreign jurisdiction
would decline to enforce those provisions. In general, the requirement
that the effect of the statutory stay-and-transfer provisions be
incorporated directly into the QFC contractually helps to ensure that a
court in a foreign jurisdiction would enforce the effect of those
provisions, regardless of whether the court would otherwise have
decided to enforce the U.S. statutory provisions.\152\ Further, the
knowledge that a court in a foreign
[[Page 42901]]
jurisdiction would reject the purported exercise of default rights in
violation of the required contractual provisions would deter covered
entities' counterparties from attempting to exercise such rights.
---------------------------------------------------------------------------
\152\ See generally Financial Stability Board, ``Principles for
Cross-border Effectiveness of Resolution Actions'' (Nov. 3, 2015),
http://www.fsb.org/wp-content/uploads/Principles-for-Cross-border-Effectiveness-of-Resolution-Actions.pdf.
---------------------------------------------------------------------------
In response to comments, the final rule exempts from the
requirements of section 252.83 a covered QFC that meets two
requirements.\153\ First, the covered QFC must state that it is
governed by the laws of the United States or a state of the United
States.\154\ It has long been clear that the laws of the United States
and the laws of a state of the United States both include U.S. federal
law, such as the U.S. Special Resolution Regimes.\155\ Therefore, this
requirement ensures that contracts that meet this exemption also
contain language that helps ensure that foreign courts will enforce the
stay-and-transfer provisions of the U.S. Special Resolution Regimes.
Second, the QFC counterparty to the covered entity must be organized
under the laws of the United States or a State,\156\ have its principal
place of business \157\ located in the United States, or be a U.S.
branch or agency.\158\ Similarly, a counterparty that is an individual
must be domiciled in the United States.\159\ This requirement helps
ensure that the FDIC will be able to quickly and easily enforce the
stay-and-transfer provisions of the U.S. Special Resolution
Regimes.\160\ This exemption is expected to significantly reduce the
burden associated with complying with the final rule while continuing
to provide assurance that the stay-and-transfer provisions of the U.S.
Special Resolution Regimes may be enforced.
---------------------------------------------------------------------------
\153\ See final rule Sec. 252.83(a).
\154\ However, a contract that explicitly provides that one or
both of the U.S. Special Resolution Regimes, including a broader set
of laws that includes a U.S. special resolution regime, is excluded
from the laws governing the QFC would not meet this exemption under
the final rule. For example, a covered QFC would not meet this
exemption if the contract stated that it was governed by the laws of
the state of New York but also stated that it was not governed by
U.S. federal law. In contrast, a contract that stated that it was
governed by the laws of the state of New York but opted out of a
specific, non-mandatory federal law (e.g., the Federal Arbitration
Act) would meet this exemption. Cf. Volt Info. Scis. v. Bd. Of Trs.,
489 U.S. 468 (1989).
\155\ Although many QFCs only explicitly state that the contract
is governed by the laws of a specific state of the United States, it
has been made clear on numerous occasions that the laws of each
state include federal law. See, e.g., Hauenstain v. Lynham, 100 U.S.
483, 490 (1979) (stating that federal law is ``as much a part of the
law of every State as its own local laws and the Constitution'');
Fid. Fed. Sav. & Loan Ass'n v. de la Cuesta, 458 U.S. 141, 157
(1982) (same); Testa v. Katt, 330 U.S. 386, 393 (1947) (``For the
policy of the federal Act is the prevailing policy in every
state.'').
\156\ For purposes of this requirement of the exemption,
``State'' means any state, commonwealth, territory, or possession of
the United States, the District of Columbia, the Commonwealth of
Puerto Rico, the Commonwealth of the Northern Mariana Islands,
American Samoa, Guam, or the United States Virgin Islands. 12 CFR
252.2(y).
\157\ See Hertz Corp. v. Friend, 559 U.S. 77 (2010) (describing
the appropriate test for principal place of business).
\158\ See final rule Sec. 252.83(a)(1)(ii).
\159\ See id.
\160\ See, e.g., Daimler AG v. Bauman, 134 S. Ct. 746 (2014);
Goodyear Dunlop Tires Operations, S.A. v. Brown, 564 U.S. 915
(2011); Hertz Corp. v. Friend, 559 U.S. 77 (2010).
---------------------------------------------------------------------------
This section of the final rule is consistent with efforts by
regulators in other jurisdictions to address similar risks by requiring
that financial firms within their jurisdictions ensure that the effect
of the similar provisions under these foreign jurisdictions' respective
special resolution regimes would be enforced by courts in other
jurisdictions, including the United States. For example, the U.K.'s
Prudential Regulation Authority (PRA) recently required certain
financial firms to ensure that their counterparties to newly created
obligations agree to be subject to stays on early termination that are
similar to those that would apply upon a U.K. firm's entry into
resolution if the financial arrangements were governed by U.K.
law.\161\ Similarly, the German parliament passed a law in November
2015 requiring German financial institutions to have provisions in
financial contracts that are subject to the law of a country outside of
the European Union that acknowledge the provisions regarding the
temporary suspension of termination rights and accept the exercise of
the powers regarding such temporary suspension under the German special
resolution regime.\162\ Additionally, the Swiss Federal Council
requires that banks ``ensure at both the individual institution and
group level that new agreements or amendments to existing agreements
which are subject to foreign law or envisage a foreign jurisdiction are
agreed only if the counterparty recognises a postponement of the
termination of agreements in accordance with'' the Swiss special
resolution regime.\163\ Japan's Financial Services Agency also revised
its supervisory guidelines for major banks to require those banks to
ensure that the effect of the statutory stay decision and statutory
special creditor protections under Japanese resolution regimes extends
to contracts governed by foreign laws.\164\
---------------------------------------------------------------------------
\161\ See PRA Rulebook: CRR Firms and Non-Authorised Persons:
Stay in Resolution Instrument 2015, (Nov. 12, 2015), http://www.bankofengland.co.uk/pra/Documents/publications/ps/2015/ps2515app1.pdf; see also Bank of England, Prudential Regulation
Authority, ``Contractual stays in financial contracts governed by
third-country law'' (PS25/15), (Nov. 2015), http://www.bankofengland.co.uk/pra/Documents/publications/ps/2015/ps2515.pdf. These PRA rules apply to PRA-authorized banks, building
societies, PRA-designated investment firms, and their qualifying
parent undertakings, including UK financial holding companies and UK
mixed financial holding companies.
\162\ See Gesetz zur Sanierung und Abwicklung von Instituten und
Finanzgruppen, Sanierungs-und Abwicklungsgesetz [SAG] [German Act on
the Reorganisation and Liquidation of Credit Institutions], Dec. 10,
2014, Sec. 60a, https://www.gesetze-im-internet.de/bundesrecht/sag/gesamt.pdf, as amended by Gesetz zur Anpassung des nationalen
Bankenabwicklungsrechts an den Einheitlichen Abwicklungsmechanismus
und die europ[auml]ischen Vorgaben zur Bankenabgabe, Nov. 2, 2015,
Artikel 1(17).
\163\ See Verordnung [uuml]ber die Finanzmarktinfrastrukturen
und das Marktverhalten im Effekten- und Derivatehandel [FinfraV]
[Ordinance on Financial Market Infrastructures and Market Conduct in
Securities and Derivatives Trading] Nov. 25, 2015, amending
Bankenverordnung vom 30. April 2014 [BankV] [Banking Ordinance of 30
April 2014] Apr. 30, 2014, SR 952.02, art. 12 paragraph 2\bis\,
translation at http://www.news.admin.ch/NSBSubscriber/message/attachments/42659.pdf; see also Erl[auml]uterungsbericht zur
Verordnung [uuml]ber die Finanzmarktinfrastrukturen und das
Marktverhalten im Effekten- und Derivatehandel (Nov. 25, 2015)
(providing commentary).
\164\ See section III-11 of Comprehensive Guidelines for
Supervision of Major Banks, etc., http://www.fsa.go.jp/common/law/guide/city.pdf.
---------------------------------------------------------------------------
Commenters also argued that it would be more appropriate for
Congress to act to obtain cross-border recognition of U.S. Special
Resolution Regimes, rather than for the Board to do so through this
final rule. The Board believes it is appropriate to adopt this final
rule in order to promote U.S. financial stability by improving the
resolvability and resilience of U.S. GSIBs and foreign GSIBs pursuant
to section 165 of the Dodd-Frank Act. Because of the current risk that
the stay-and-transfer provisions of U.S. Special Resolution Regimes may
not be recognized under the laws of other jurisdictions, section 252.83
of the final rule requires similar contractual recognition to help
ensure that courts in foreign jurisdictions will recognize these
provisions.
This requirement would advance the goal of the final rule of
removing QFC-related obstacles to the orderly resolution of a GSIB. As
discussed above, restrictions on the exercise of QFC default rights are
an important prerequisite for an orderly GSIB resolution. Congress
recognized the importance of such restrictions when it enacted the
stay-and-transfer provisions of the U.S. Special Resolution Regimes. As
demonstrated by the 2007-2009 financial crisis, the modern financial
system is global in scope, and covered entities are party to large
volumes of QFCs with connections to foreign
[[Page 42902]]
jurisdictions. The stay-and-transfer provisions of the U.S. Special
Resolution Regimes would not achieve their purpose of facilitating
orderly resolution in the context of the failure of a GSIB with large
volumes of QFCs if such QFCs could escape the effect of those
provisions. To remove doubt about the scope of coverage of these
provisions, the requirements of section 252.83 of the final rule would
ensure that the stay-and-transfer provisions apply as a matter of
contract to all covered QFCs, wherever the transaction. This will
advance the resolvability goals of the Dodd-Frank Act and the FDI Act
and improve the resiliency of firms subject to the requirements.
E. Prohibited Cross-Default Rights (Section 252.84 of the Final Rule)
Definitions. Section 252.84 of the final rule, like the proposal,
pertains to cross-default rights in QFCs between covered entities and
their counterparties, many of which are subject to credit enhancements
(such as a guarantee) provided by an affiliate of the covered entity.
Because credit enhancements on QFCs are themselves ``qualified
financial contracts'' under the Dodd-Frank Act's definition of that
term (which this final rule adopts), the final rule includes the
following additional definitions in order to facilitate a precise
description of the relationships to which it would apply. These
definitions are the same as under the proposal since no comments were
received on these definitions.
First, the final rule distinguishes between a credit enhancement
and a ``direct QFC,'' defined as any QFC that is not a credit
enhancement.\165\ The final rule also defines ``direct party'' to mean
a covered entity that is itself a party to the direct QFC, as distinct
from an entity that provides a credit enhancement.\166\ In addition,
the final rule defines ``affiliate credit enhancement'' to mean ``a
credit enhancement that is provided by an affiliate of a party to the
direct QFC that the credit enhancement supports,'' as distinct from a
credit enhancement provided by either the direct party itself or by an
unaffiliated party.\167\ Moreover, the final rule defines ``covered
affiliate credit enhancement'' to mean an affiliate credit enhancement
provided by a covered entity or excluded bank and defines ``covered
affiliate support provider'' to mean the affiliate of the covered
entity that provides the covered affiliate credit enhancement.\168\
Finally, the final rule defines the term ``supported party'' to mean
any party that is the beneficiary of the covered affiliate support
provider's obligations under a covered affiliate credit enhancement
(that is, the QFC counterparty of a direct party, assuming that the
direct QFC is subject to a covered affiliate credit enhancement).\169\
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\165\ See final rule Sec. 252.84(c)(2).
\166\ See final rule Sec. 252.84(c)(1).
\167\ See final rule Sec. 252.84(c)(3).
\168\ See final rule Sec. 252.84(e)(2)-(3).
\169\ See final rule Sec. 252.84(e)(4).
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General prohibitions. The final rule, like the proposal, prohibits
a covered entity from being party to a covered QFC that allows for the
exercise of any default right that is related, directly or indirectly,
to the entry into resolution of an affiliate of the covered entity,
subject to the exceptions discussed below.\170\ The final rule also
generally prohibits a covered entity from being party to a covered QFC
that would prohibit the transfer of any credit enhancement applicable
to the QFC (such as another entity's guarantee of the covered entity's
obligations under the QFC), along with associated obligations or
collateral, upon the entry into resolution of an affiliate of the
covered entity.\171\
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\170\ See final rule Sec. 252.84(b)(1). A few commenters
requested that the Board clarify that covered QFCs that do not
contain the cross-default rights or transfer restrictions on credit
enhancement that are prohibited by section 252.84 would not be
required to be remediated. This reading of section 252.84 of the
proposed and final rule is correct. In addition, section 252.84(a)
of the final rule provides the requested clarity.
\171\ See final rule Sec. 252.84(b)(2). This prohibition is
subject to an exception that would allow supported parties to
exercise default rights with respect to a QFC if the supported party
is prohibited from being the beneficiary of a credit enhancement
provided by the transferee under any applicable law, including the
Employee Retirement Income Security Act of 1974 and the Investment
Company Act of 1940. This exception is substantially similar to an
exception to the transfer restrictions in section 2(f) of the ISDA
2014 Resolution Stay Protocol (2014 Protocol) and the Universal
Protocol, which was added to address concerns expressed by asset
managers during the drafting of the 2014 Protocol.
One commenter requested that the exception be broadened to
include transfers that would result in the supported party being
unable, without further action, to satisfy the requirements of any
law applicable to the supported party. As an example of a type of
transfer that the commenter intended to be included within the
broadened exception, the commenter stated that the supported party
would be able to prevent the transfer if it would result in less
favorable tax treatment. The exception would seem to also include
filing requirements that may arise as a result of transfer or other
requirements that could be satisfied with minimal ``action'' by, or
cost to, the supported party. More generally, the scope of the laws
that supported parties deem themselves to satisfy and the method of
such satisfaction is unclear and potentially very broad.
The final rule retains the exception as proposed. The requested
exception would add uncertainty as to whether transfers may be made
during the stay period and potentially subsume the transfer
prohibition.
---------------------------------------------------------------------------
One commenter expressed strong support for these provisions.\172\
Another commenter expressed support for this provision as currently
limited in scope under the proposal to prohibited cross-default rights
and requested that the scope not be expanded. The Board's final rule
retains the same scope as the proposal.
---------------------------------------------------------------------------
\172\ This commenter also expressed support for Congressional
amendment of the U.S. Bankruptcy Code.
---------------------------------------------------------------------------
A number of commenters representing counterparties to covered
entities objected to section 252.84 of the proposal and requested the
elimination of this provision. These commenters expressed concern about
limitations on counterparties' exercise of default rights during
insolvency proceedings and argued that rights should not be taken away
from contracting parties other than where limitation of such rights is
necessary for public policy reasons and the resolution process is
controlled by a regulatory authority with particular expertise in the
resolution of the type of entity subject to the proceedings. Certain
commenters argued that eliminating cross-default termination rights
undermines the ability of QFC counterparties to effectively manage and
mitigate their exposure to market and credit risk to a GSIB and
interferes with market forces. One commenter similarly argued that,
unless the Board takes appropriate measures to strengthen the financial
condition and creditworthiness of a failing GSIB during and after the
temporary stay, the stay will only expose QFC counterparties to an
additional 48 hours of credit risk exposure without achieving the
orderly resolution goals of the rule. Another commenter argued that
non-defaulting counterparties should not be prevented from filing
proofs of claim or other pleadings in a bankruptcy case during the stay
period, since bankruptcy deadlines might pass and leave the
counterparty unable to collect the unsecured creditor dividend.
Commenters contended that restrictions on cross-default rights may lead
to pro-cyclical behavior with asset managers moving funds away from
covered entities as soon as those entities show signs of distress, and
perhaps even in normal situations, and would disadvantage non-GSIB
parties (e.g., end users who rarely receive initial margin from GSIB
counterparties and are less well protected against a GSIB
default).\173\
---------------------------------------------------------------------------
\173\ One commenter stated that, to the extent the final rule
prevents an insurer from terminating QFC transactions upon the
credit rating downgrade of a GSIB counterparty, the insurer may be
in violation of state insurance laws that typically impose strict
counterparty credit rating guidelines and limits. This commenter did
not give any specific examples of such laws. Counterparties,
including insurance companies, should evaluate and comply with all
relevant applicable requirements.
---------------------------------------------------------------------------
[[Page 42903]]
Some commenters argued that, if these rights must be restricted by
law, Congress should impose such restrictions and that the requirements
of the proposed rule circumvented the legislative process by creating a
de facto amendment to the U.S. Bankruptcy Code that forecloses
countless QFC counterparties from exercising their rights of cross-
default protection under section 362 of the U.S. Bankruptcy Code. Some
of these commenters argued that parties cannot by contract alter the
U.S. Bankruptcy Code's provisions, such as the administrative priority
of a claim in bankruptcy, and one commenter suggested that non-covered
entity counterparties may challenge the legality of contractual stays
on the exercise of default rights if a GSIB becomes distressed. Certain
commenters also questioned the Board's ability to rely on section 165
of the Dodd-Frank Act in imposing these requirements and argued that
making SPOE resolution possible under the U.S. Bankruptcy Code was not
an appropriate justification for this rule. Other commenters, however,
argued that the provisions of the proposed rule were necessary to
address systemic risks posed by the exemption for QFCs in the U.S.
Bankruptcy Code.
As an alternative to eliminating these requirements, these
commenters expressed the view that, if the Board moves forward with
these provisions, the final rule should include at least those minimum
creditor protections established by the Universal Protocol. Certain
commenters also argued that this provision was overly broad in that it
covered not only U.S. federal resolution and insolvency proceedings but
also state and foreign resolution and insolvency proceedings.\174\
Certain commenters also urged the Board to provide a limited exception
to these restrictions, if retained in the final rule, to help ensure
the continued functioning of physical commodities markets.\175\
---------------------------------------------------------------------------
\174\ Certain commenters also indicated that these provisions
should only apply to U.S. Special Resolution Regimes, which provide
certain protections for counterparties, or, at most, to U.S. Special
Resolution Regimes, resolution under the Securities Investor
Protection Act, and insolvency under Chapter 11 of the U.S.
Bankruptcy Code. That commenter noted that liquidation and
insolvency under Chapter 7 of the Bankruptcy Code do not seek to
preserve the GSIB as a viable entity, which is an objective of this
proposal. As discussed later, the rule seeks to facilitate the
resolution of a GSIB outside of U.S. Special Resolution Regimes,
including under the U.S. Bankruptcy Code, and is intended to
facilitate other approaches to GSIB resolution. Therefore, the final
rule applies these provisions in the same way as the proposal. In
addition, the additional creditor protections for supported parties
under the final rule permit contractual requirements that any
transferee not be in bankruptcy proceedings and that the credit
support provider not be in bankruptcy proceedings other than a
Chapter 11 proceeding. See final rule Sec. 252.84(f).
\175\ In particular, these commenters requested that, when a
covered entity defaults on any physical delivery obligation to any
counterparty following the insolvency of an affiliate of a covered
entity, its counterparties with obligations to deliver or take
delivery of physical commodities within a short time frame after the
default should be able to immediately terminate all trades (both
physical and financial) with the covered entity. The final rule,
like the proposal, allows covered QFCs to permit a counterparty to
exercise its default rights under a covered QFC if the covered
entity has failed to pay or perform its obligations under the
covered QFC. See final rule Sec. 252.84(d). The final rule, like
the proposal, also allows covered QFCs to permit a counterparty to
exercise its default rights under a covered QFC if the covered
entity has failed to pay or perform on other contracts between the
same parties and the failure gives rise to a default right in the
covered QFC. See id. These exceptions should help reduce credit risk
and ensure the smooth operation of the physical commodities markets
without permitting one failure to pay or perform by a covered entity
to allow a potentially large number of its counterparties that are
not directly affected by the failure to exercise their default
rights and thereby endanger the viability of the covered entity.
---------------------------------------------------------------------------
Some commenters argued that the Board should eliminate the stay on
default rights that are related ``indirectly'' to an affiliate of the
direct party becoming subject to insolvency proceedings, claiming it is
unclear what constitutes a right related ``indirectly'' to insolvency
and noting that any default right exercised by a counterparty after an
affiliate of that counterparty enters resolution could arguably be
motivated by the affiliate's entry into resolution.
A primary purpose of these restrictions is to facilitate the
resolution of a GSIB outside of Title II of the Dodd-Frank Act,
including under the U.S. Bankruptcy Code. As discussed above, the
potential for mass exercises of QFC default rights is one reason why a
GSIB's failure could cause severe damage to financial stability. In the
context of an SPOE resolution, if the GSIB parent's entry into
resolution led to the mass exercise of cross-default rights by the
subsidiaries' QFC counterparties, then the subsidiaries could
themselves fail or experience financial distress. Moreover, the mass
exercise of QFC default rights could entail asset fire sales, which
likely would affect other financial companies and undermine financial
stability. Similar disruptive results can occur with an MPOE resolution
of a GSIB affiliate if an otherwise performing GSIB entity is subject
to having its QFCs terminated or accelerated as a result of the default
of its affiliate.
In an SPOE resolution, this damage can be avoided if actions of the
following two types are prevented: The exercise of direct default
rights against the top-tier holding company that has entered
resolution, and the exercise of cross-default rights against the
operating subsidiaries based on their parent's entry into resolution.
(Direct default rights against the subsidiaries would not be
exercisable, because the subsidiaries would not enter resolution.) In
an MPOE resolution, this damage occurs from exercise of default rights
against a performing entity based on the failure of an affiliate.
Title II of the Dodd-Frank Act's stay-and-transfer provisions would
address both direct default rights and cross-default rights. But, as
explained above, no similar statutory provisions would apply to a
resolution under the U.S. Bankruptcy Code. The final rule attempts to
address these obstacles to orderly resolution by extending the stay-
and-transfer provisions to any type of resolution of a covered entity.
Similarly, the final rule would facilitate a transfer of the GSIB
parent's interests in its subsidiaries, along with any credit
enhancements it provides for those subsidiaries, to a solvent financial
company by prohibiting covered entities from having QFCs that would
allow the QFC counterparty to prevent such a transfer or to use it as a
ground for exercising default rights.\176\
---------------------------------------------------------------------------
\176\ See final rule Sec. 252.84(b).
---------------------------------------------------------------------------
The final rule also is intended to facilitate other approaches to
GSIB resolution. For example, it would facilitate a similar resolution
strategy in which a U.S. depository institution subsidiary of a GSIB
enters resolution under the FDI Act while its subsidiaries continue to
meet their financial obligations outside of resolution.\177\ Similarly,
the final rule would facilitate the orderly resolution of a foreign
GSIB under its home jurisdiction resolution regime by preventing the
exercise of cross-default rights against the foreign GSIB's U.S.
operations. The final rule would also facilitate the resolution of an
IHC of a foreign GSIB, and the recapitalization of its U.S. operating
subsidiaries, as part of a broader MPOE resolution strategy under which
the foreign GSIB's operations in other
[[Page 42904]]
regions would enter separate resolution proceedings. Finally, the final
rule would broadly prevent the unanticipated failure of any one GSIB
entity from bringing about the disorderly failures of its affiliates by
preventing the affiliates' QFC counterparties from using the first
entity's failure as a ground for exercising default rights against
those affiliates that continue to meet their obligations.
---------------------------------------------------------------------------
\177\ As discussed above, the FDI Act would limit the exercise
of direct default rights against the depository institution, but
does not address the threat posed to orderly resolution by cross-
default rights in the QFCs of the depository institution's
subsidiaries. This final rule would facilitate orderly resolution
under the FDI Act by filling that gap. See final rule Sec.
252.84(h).
---------------------------------------------------------------------------
The final rule is intended to enhance the potential for orderly
resolution of a GSIB under the U.S. Bankruptcy Code, the FDI Act, or a
similar resolution regime. The risks to an orderly resolution under the
U.S. Bankruptcy Code include separate resolution or insolvency
proceedings, including proceedings in non-U.S. jurisdictions.
Therefore, by staying default rights arising from affiliates entering
such proceedings, the final rule would advance the Dodd-Frank Act's
goal of making orderly GSIB resolution workable under the U.S.
Bankruptcy Code.\178\
---------------------------------------------------------------------------
\178\ See 12 U.S.C. 5365(d).
---------------------------------------------------------------------------
Likewise, the final rule retains the prohibition against
contractual provisions that permit the exercise of default rights that
are indirectly related to the resolution of an affiliate. QFCs may
include a number of default rights triggered by an event that is not
the resolution of an affiliate but is caused by the resolution, such as
a credit rating downgrade in response to the resolution. A primary
purpose of the final rule is to prevent early terminations caused by
the resolution of an affiliate. A regulation that specifies each type
of early termination provision that should be stayed would be over-
inclusive, under-inclusive, and easy to evade. Similarly, a stay of
default rights that are only directly related to the resolution of an
affiliate could increase the likelihood of litigation to determine if
the relationship between the default right and the affiliate resolution
was sufficient to be considered ``directly'' related. The final rule
attempts to decrease such uncertainty and litigation risk by including
default rights that are related (i.e., directly or indirectly) to the
resolution of an affiliate.
Moreover, the final rule does not affect parties' rights under the
U.S. Bankruptcy Code. As explained above, the regulation does not
prohibit a covered QFC from permitting the exercise of default rights
against a covered entity that has entered bankruptcy proceedings.\179\
Therefore, counterparties to a covered entity in bankruptcy would be
able to exercise their existing contractual default rights to the full
extent permitted under any applicable safe harbor to the automatic stay
of the U.S. Bankruptcy Code.
---------------------------------------------------------------------------
\179\ See final rule Sec. 252.84(d)(1).
---------------------------------------------------------------------------
The final rule should also benefit the counterparties of a
subsidiary of a failed GSIB by preventing the severe distress or
disorderly failure of the subsidiary and allowing it to continue to
meet its obligations. While it may be in the individual interest of any
given counterparty to exercise any available rights to run on a
subsidiary of a failed GSIB, the mass exercise of such rights could
harm the counterparties' collective interest by causing an otherwise-
solvent subsidiary to fail. Therefore, like the automatic stay in
bankruptcy, which serves to maximize creditors' ultimate recoveries by
preventing a disorderly liquidation of the debtor, the final rule seeks
to mitigate this collective action problem to the benefit of the failed
firm's creditors and counterparties by preventing a disorderly
resolution. And because many creditors and counterparties of GSIBs are
themselves systemically important financial firms, improving outcomes
for those creditors and counterparties should further protect the
financial stability of the United States.
General creditor protections. While the restrictions of the final
rule are intended to facilitate orderly resolution, they may also
diminish the ability of covered entities' QFC counterparties to include
certain protections for themselves in covered QFCs, as noted by certain
commenters. In order to reduce this effect, the final rule, like the
proposal, includes several substantial exceptions to the
restrictions.\180\ These permitted creditor protections are intended to
allow creditors to exercise cross-default rights outside of an orderly
resolution of a GSIB (as described above) and therefore would not be
expected to undermine such a resolution.
---------------------------------------------------------------------------
\180\ See final rule Sec. 252.84(d).
---------------------------------------------------------------------------
First, in order to ensure that the proposed prohibitions would
apply only to cross-default rights (and not direct default rights), the
final rule provides that a covered QFC may permit the exercise of
default rights based on the direct party's entry into a resolution
proceeding.\181\ This provision helps to ensure that, if the direct
party to a QFC were to enter bankruptcy, its QFC counterparties could
exercise any relevant direct default rights. Thus, a covered entity's
direct QFC counterparties would not risk the delay and expense
associated with becoming involved in a bankruptcy proceeding and would
be able to take advantage of default rights that would fall within the
U.S. Bankruptcy Code's safe harbor provisions.
---------------------------------------------------------------------------
\181\ See final rule Sec. 252.84(d)(1). The proposal exempted
from this creditor protection provision proceedings under a U.S. or
foreign special resolution regime. As explained in the proposal,
special resolution regimes typically stay direct default rights, but
may not stay cross-default rights. For example, as discussed above,
the FDI Act stays direct default rights, see 12 U.S.C.
1821(e)(10)(B), but does not stay cross-default rights, whereas the
Dodd-Frank Act's OLA stays direct default rights and cross-defaults
arising from a parent's receivership, see 12 U.S.C. 5390(c)(10)(B)
and 5390(c)(16). The proposed exemption of special resolution
regimes from the creditor protection provisions was intended to help
ensure that special resolution regimes that do not stay cross-
defaults, such as the FDI Act, would not disrupt the orderly
resolution of a GSIB under the U.S. Bankruptcy Code or other
ordinary insolvency proceedings.
One commenter requested the Board revise this provision to
clarify that default rights based on a covered entity or an
affiliate entering resolution under the FDI Act or Title II of the
Dodd-Frank Act are not prohibited but instead are merely subject to
the terms of such regimes. The commenter requested the Board clarify
that such default rights are permitted so long as they are subject
to the provisions of the FDI Act or Title II of the Dodd-Frank Act
as required under section 225.83. The final rule eliminates this
proposed exemption for special resolution regimes because the rule
separately addresses cross-defaults arising from the FDI Act and
because foreign special resolution regimes, along with efforts in
other jurisdictions to contractually recognize stays of default
rights under those regimes, should reduce the risk that such a
regime should pose to the orderly resolution of a GSIB under the
U.S. Bankruptcy Code or other ordinary insolvency proceedings.
---------------------------------------------------------------------------
The final rule also allows covered QFCs to permit the exercise of
default rights based on the failure of the direct party, a covered
affiliate support provider, or a transferee that assumes a credit
enhancement to satisfy its payment or delivery obligations under the
direct QFC or credit enhancement.\182\ Moreover, the final rule allows
covered QFCs to permit the exercise of a default right in one QFC that
is triggered by the direct party's failure to satisfy its payment or
delivery obligations under another contract between the same
parties.\183\ This exception takes appropriate account of the
interdependence that exists among the contracts in effect between the
same counterparties.
---------------------------------------------------------------------------
\182\ See final rule Sec. 252.84(d)(2)-(3). These provisions
should respond to comments requesting that the final rule confirm
the ability of a covered entity's counterparty to exercise default
rights arising from the failure of a direct party to satisfy a
payment or delivery obligation during the stay period. But see final
rule Sec. 252.83(c).
\183\ See final rule Sec. 252.84(d)(2).
---------------------------------------------------------------------------
As explained in the proposal, the exceptions in the final rule for
the creditor protections described above are intended to help ensure
that the final rule permits a covered entity's QFC
[[Page 42905]]
counterparties to protect themselves from imminent financial loss and
does not create a risk of delivery gridlocks or daisy-chain effects, in
which a covered entity's failure to make a payment or delivery when due
leaves its counterparty unable to meet its own payment and delivery
obligations (the daisy-chain effect would be prevented because the
covered entity's counterparty would be permitted to exercise its
default rights, such as by liquidating collateral). These exceptions
are generally consistent with the treatment of payment and delivery
obligations under the U.S. Special Resolution Regimes.\184\
---------------------------------------------------------------------------
\184\ See 12 U.S.C. 1821(e)(8)(G)(ii), 5390(c)(8)(F)(ii)
(suspending payment and delivery obligations for one business day or
less).
---------------------------------------------------------------------------
These exceptions also help to ensure that a covered entity's QFC
counterparty would not risk the delay and expense associated with
becoming involved in a bankruptcy proceeding, since, unlike a typical
creditor of an entity that enters bankruptcy, the QFC counterparty
would retain its ability under the U.S. Bankruptcy Code's safe harbors
to exercise direct default rights. This should further reduce the
counterparty's incentive to run. Reducing incentives to run in the
period leading up to resolution promotes orderly resolution, since a
QFC creditor run (such as a mass withdrawal of repo funding) could lead
to a disorderly resolution and pose a threat to financial stability.
Additional creditor protections for supported QFCs. The final rule,
like the proposal, allows the inclusion of additional creditor
protections for a non-defaulting counterparty that is the beneficiary
of a credit enhancement from an affiliate of the covered entity that is
also a covered entity or excluded bank.\185\ The final rule allows
these creditor protections in recognition of the supported party's
interest in receiving the benefit of its credit enhancement. These
creditor protections would not undermine an SPOE resolution of a GSIB.
---------------------------------------------------------------------------
\185\ See final rule Sec. 252.84(f).
---------------------------------------------------------------------------
Where a covered QFC is supported by a covered affiliate credit
enhancement,\186\ the covered QFC and the credit enhancement would be
permitted to allow the exercise of default rights under the
circumstances discussed below after the expiration of a stay period.
Under the final rule, the applicable stay period would begin when the
credit support provider enters resolution and would end at the later of
5:00 p.m. (eastern time) on the next business day and 48 hours after
the entry into resolution.\187\ This portion of the final rule is
similar to the stay treatment provided in a resolution under the OLA or
the FDI Act.\188\
---------------------------------------------------------------------------
\186\ Note that the exception in section 252.84(f) of the final
rule would not apply with respect to credit enhancements that are
not covered affiliate credit enhancements. In particular, it would
not apply with respect to a credit enhancement provided by a non-
U.S. entity of a foreign GSIB, which would not be a covered entity
or excluded bank under the final rule. See final rule Sec.
252.84(e)(2) (defining ``covered affiliate credit enhancement'').
\187\ See final rule Sec. 252.84(g)(1).
\188\ See 12 U.S.C. 1821(e)(10)(B)(I), 5390(c)(10)(B)(i),
5390(c)(16)(A). While the final rule's stay period is similar to the
stay periods that would be imposed by the U.S. Special Resolution
Regimes, it could run longer than those stay periods under some
circumstances.
---------------------------------------------------------------------------
Under the final rule, contractual provisions may permit the
exercise of default rights at the end of the stay period if the covered
affiliate credit enhancement has not been transferred away from the
covered affiliate support provider and that support provider becomes
subject to a resolution proceeding other than a proceeding under
Chapter 11 of the U.S. Bankruptcy Code.\189\ QFCs may also permit the
exercise of default rights at the end of the stay period if the
transferee (if any) of the credit enhancement enters a resolution
proceeding, protecting the supported party from a transfer of the
credit enhancement to a transferee that is unable to meet its financial
obligations.\190\
---------------------------------------------------------------------------
\189\ See final rule Sec. 252.84(f)(1). Chapter 11 (11 U.S.C.
1101-1174) is the portion of the U.S. Bankruptcy Code that provides
for the reorganization of the failed company, as opposed to its
liquidation, and is generally well-understood by market
participants.
\190\ See final rule Sec. 252.84(f)(2).
---------------------------------------------------------------------------
QFCs may also permit the exercise of default rights at the end of
the stay period if the original credit support provider does not
remain, and no transferee becomes, obligated to the same (or
substantially similar) extent as the original credit support provider
was obligated immediately prior to entering a resolution proceeding
(including a Chapter 11 proceeding) with respect to (a) the covered
affiliate credit enhancement, (b) all other covered affiliate credit
enhancements provided by the credit support provider on any other
covered QFCs between the same parties, and (c) all credit enhancements
provided by the credit support provider between the direct party and
affiliates of the direct party's QFC counterparty.\191\ Such creditor
protections are permitted in order to prevent the support provider or
the transferee from ``cherry picking'' by assuming only those QFCs of a
given counterparty that are favorable to the support provider or
transferee. Title II of the Dodd-Frank Act and the FDI Act contain
similar provisions to prevent cherry picking.
---------------------------------------------------------------------------
\191\ See final rule Sec. 252.84(f)(3).
---------------------------------------------------------------------------
Finally, if the covered affiliate credit enhancement is transferred
to a transferee, the QFC may permit the non-defaulting counterparty to
exercise default rights at the end of the stay period unless either (a)
all of the covered affiliate support provider's ownership interests in
the direct party are also transferred to the transferee or (b)
reasonable assurance is provided that substantially all of the covered
affiliate support provider's assets (or the net proceeds from the sale
of those assets) will be transferred or sold to the transferee in a
timely manner.\192\ These conditions help to assure the supported party
that the transferee would be at least roughly as financially capable of
providing the credit enhancement as the covered affiliate support
provider. Title II of the Dodd-Frank Act similarly requires that
certain conditions be met with respect to affiliate credit
enhancements.\193\
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\192\ See final rule Sec. 252.84(f)(4).
\193\ See 12 U.S.C. 5390(c)(16)(A).
---------------------------------------------------------------------------
Commenters generally expressed strong support for these exclusions
but also requested that these exclusions be broadened in a number of
ways. Certain commenters urged the Board to broaden the exclusions to
permit, after trigger of the stay-and-transfer provisions, the exercise
of default rights by a counterparty against a direct counterparty or
covered support provider with respect to any default right under the
QFC (other than a default right explicitly based on the failure of an
affiliate) and not just with respect to defaults resulting from payment
or delivery failure or the direct party becoming subject to certain
resolution or insolvency proceedings (e.g., failure to maintain a
license or certain capital level, materially breaching its
representations under the QFC). Certain commenters contended that, at a
minimum, the final rule should provide for creditor protections that
meet the minimum standards set forth by the Universal Protocol. One
commenter specifically identified three creditor protections found in
the Universal Protocol that it argued the Board should include in
section 252.84: (1) Priority rights in a bankruptcy proceeding against
the transferee or original credit support provider (if the QFC
providing credit support was not transferred); (2) a right to submit
claims in the insolvency proceeding of the insolvent credit support
provider if the transferee becomes insolvent; and (3) the ability to
declare a default and close
[[Page 42906]]
out of both the original QFC with the direct counterparty as well as
QFCs with the transferee if the transferee defaults under the
transferred QFC or under any other QFC with the non-defaulting
counterparty, subject to the contractual terms and consistent with
applicable law. Another commenter argued for creditor protections not
found in the Universal Protocol, including that the transferee be
required to be a U.S. person and be registered with and licensed by the
primary regulator of either the direct counterparty or transferor
entity.
The final rule does not include the additional creditor protections
of the Universal Protocol or other creditor protections requested by
commenters. As explained in the proposal and below, the additional
creditor protections of the Universal Protocol do not appear to
materially diminish the prospects for an orderly resolution of a GSIB
because the Universal Protocol includes a number of desirable features
that the final rule otherwise lacks.\194\ Providing additional
circumstances under which default rights may be exercised during and
immediately after the stay period, in the absence of any
counterbalancing benefits to resolution, would increase the risk of a
disorderly resolution of a GSIB in contravention of the purposes of the
rule.
---------------------------------------------------------------------------
\194\ See 81 FR 29169, 29182 (May 11, 2016).
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One commenter also argued that transfer should be limited to a
bridge bank under the FDI Act or a bridge financial company under Title
II of the Dodd-Frank Act to ensure that the transferee is more likely
to be able to satisfy the obligations of a credit support provider and
is subject to regulatory oversight. Section 252.84 of the final rule
permits QFCs to include provisions allowing a counterparty to exercise
its default rights against a direct party that enters resolution under
the FDI Act or Title II of the Dodd-Frank Act, other than the limited
case contemplated by section 252.84(h) of the final rule. The Board is
not adopting the proposed additional creditor protection because it
would defeat in large part the purpose of section 252.84 and
potentially create confusion regarding the requirements and purposes of
sections 252.83 and 252.84 of the final rule.\195\
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\195\ To the extent the commenter's reference to ``bridge
financial company'' was not only to a bridge financial company under
Title II of the Dodd-Frank Act, the requested amendment would not
appear to provide a meaningful reduction in credit risk to
counterparties compared to the creditor protections permitted under
section 252.84 of the final rule and those available under the
Universal Protocol and U.S. Protocol, discussed below.
---------------------------------------------------------------------------
A few commenters expressed concern that the additional creditor
protections applied only to QFCs supported by a credit enhancement
provided by a ``covered affiliate support provider'' (i.e., an
affiliate that is a covered entity) and noted that foreign GSIBs often
will have their QFCs supported by a non-U.S. affiliate that is not a
covered entity. Such non-U.S. affiliate credit supporter providers
would not be able to rely on the additional creditor protections for
supported QFCs. As the proposal explained, ``Such credit enhancements
[are] excluded in order to help ensure that the resolution of a non-
U.S. entity would not negatively affect the financial stability of the
United States by allowing for the exercise of default rights against a
covered entity.'' \196\
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\196\ 81 FR 29169, 29180 n.92 (May 11, 2016) (``Note that the
exception in Sec. 252.84(g) of the proposed rule would not apply
with respect to credit enhancements that are not covered affiliate
credit enhancements. In particular, it would not apply with respect
to a credit enhancement provided by a non-U.S. entity of a foreign
GSIB, which would not be a covered entity under the proposal. Such
credit enhancements would be excluded in order to help ensure that
the resolution of a non-U.S. entity would not negatively affect the
financial stability of the United States by allowing for the
exercise of default rights against a covered entity.''). See also
final rule Sec. 252.84(f).
---------------------------------------------------------------------------
One commenter requested clarification that the creditors of a non-
U.S. credit support provider are permitted to exercise any and all
rights against that non-U.S. credit support provider that they could
exercise under the non-U.S. resolution regime applicable to that non-
U.S. credit support provider. In general, covered entities may be
entities organized or operating in the United States or, with respect
to U.S. GSIBs, abroad. The final rule, like the proposal, is limited to
QFCs to which a covered entity is a party. Section 252.84 of the final
rule generally prohibits QFCs to which a covered entity is a party from
allowing the exercise of cross-default rights of the covered QFC,
regardless of whether the affiliate entering resolution and/or the
credit support provider is organized or operates in the United States.
Another commenter expressed concern that the proposed section
252.84(g)(3) (section 252.84(f)(3) of the final rule) would provide a
right without a remedy because, if the covered affiliate credit support
provider is no longer obligated and no transferee has taken on the
obligation, the non-covered entity counterparty may have only a breach
of contract claim against an entity that has transferred all of its
assets to a third party. The creditor protections of section 252.84, if
triggered, permit contractual provisions allowing the exercise of
existing default rights against the direct party to the covered QFC, as
well as any existing rights against the credit enhancement provider.
Another commenter suggested revising section 252.84(g) (section
252.84(f) of the final rule) to clarify that, for a covered direct QFC
supported by a covered affiliate credit enhancement, the covered direct
QFC and the covered affiliate credit enhancement may permit the
exercise of a default right after the stay period that is related,
directly or indirectly, to the covered affiliate support provider
entering into resolution proceedings. This reading is incorrect and
revising the rule as requested would largely defeat the purpose of
section 252.84 of the final rule by merely delaying QFC termination en
masse.
Some commenters also requested specific provisions related to
physical commodity contracts, including a provision that would allow
regulators to override a stay if necessary to avoid disruption of the
supply or prevent exacerbation of price movements in a commodity or a
provision that would allow the exercise of default rights of
counterparties delivering or taking delivery of physical commodities if
a covered entity defaults on any physical delivery obligation to any
counterparty. As noted above, QFCs may permit a counterparty to
exercise its default rights immediately, even during the stay period,
if the covered entity fails to pay or perform on the covered QFC with
the counterparty (or another contract between the same parties that
gives rise to a default under the covered QFC).
Creditor protections related to FDI Act proceedings. In the case of
a covered QFC that is supported by a covered affiliate credit
enhancement, both the covered QFC and the credit enhancement would be
permitted to allow the exercise of default rights related to the credit
support provider's entry into resolution proceedings under the FDI Act
\197\ only under the following circumstances: (a) After the FDI Act
stay period,\198\ if the credit enhancement is not transferred under
the relevant provisions of the FDI Act \199\ and associated
regulations, and (b) during the FDI Act stay period, to the extent
[[Page 42907]]
that the default right permits the supported party to suspend
performance under the covered QFC to the same extent as that party
would be entitled to do if the covered QFC were with the credit support
provider itself and were treated in the same manner as the credit
enhancement.\200\ This provision is intended to ensure that a QFC
counterparty of a subsidiary of a bank that goes into FDI Act
receivership can receive the same level of protection that the FDI Act
provides to QFC counterparties of the bank itself. No comments were
received on this aspect of the proposal and the final rule contains no
changes from the proposal.
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\197\ As discussed above, the FDI Act stays direct default
rights against the failed depository institution but does not stay
the exercise of cross-default rights against its affiliates.
\198\ Under the FDI Act, the relevant stay period runs until
5:00 p.m. (eastern time) on the business day following the
appointment of the FDIC as receiver. 12 U.S.C. 1821(e)(10)(B)(I).
See also final rule Sec. 252.81.
\199\ 12 U.S.C. 1821(e)(9)-(10).
\200\ See final rule Sec. 252.84(h).
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Prohibited terminations. In case of a legal dispute as to a party's
right to exercise a default right under a covered QFC, the final rule,
like the proposal, requires that a covered QFC must provide that, after
an affiliate of the direct party has entered a resolution proceeding,
(a) the party seeking to exercise the default right bears the burden of
proof that the exercise of that right is indeed permitted by the
covered QFC, and (b) the party seeking to exercise the default right
must meet a ``clear and convincing evidence'' standard, a similar
standard,\201\ or a more demanding standard.\202\ The purpose of this
requirement is to deter the QFC counterparty of a covered entity from
thwarting the purpose of the final rule by exercising a default right
because of an affiliate's entry into resolution under the guise of
other default rights that are unrelated to the affiliate's entry into
resolution.
---------------------------------------------------------------------------
\201\ The reference to a ``similar'' burden of proof is intended
to allow covered QFCs to provide for the application of a standard
that is analogous to clear and convincing evidence in jurisdictions
that do not recognize that particular standard. A covered QFC is not
permitted to provide for a lower standard.
\202\ See final rule Sec. 252.84(i).
---------------------------------------------------------------------------
A few commenters requested guidance on how to satisfy the burden of
proof of clear and convincing evidence so that they may avoid seeking
such clarity through litigation. Other commenters urged that this
standard was not appropriate and should be eliminated. In particular, a
number of commenters expressed concern that the burden of proof
requirements, which are more stringent than the burden of proof
requirements for typical contractual disputes adjudicated in a court,
unduly hamper the creditor protections of counterparties and impose a
burden directly on non-covered entities, who should be able to exercise
default rights if it is commercially reasonable in the context. One
commenter contended that this burden, combined with the stay on default
rights related ``indirectly'' to an affiliate entering insolvency
proceedings, effectively prohibits counterparties from exercising any
default rights during the stay period. These commenters argued that it
is inappropriate for the Board in a rulemaking to alter the burden of
proof for contractual disputes. One commenter suggested that, in a
scenario involving a master agreement with some transactions out of the
money and others in the money, the defaulting GSIB will have a lower
burden of proof for demonstrating that it is owed money than for
demonstrating that it owes money, should the non-GSIB counterparty
exercise its termination rights. Certain commenters suggested instead
that the final rule shift the burden and instead adopt a rebuttable
presumption that the non-defaulting counterparty's exercise of default
rights is permitted under the QFC unless the defaulting covered entity
demonstrates otherwise. One commenter requested that the burden of
proof not apply to the exercise of direct default rights.
The final rule retains the proposed burden of proof requirements.
The requirement is based on a primary goal of the final rule--to avoid
the disorderly termination of QFCs in response to the failure of an
affiliate of a GSIB. The requirement accomplishes this goal by making
clear that a party that exercises a default right when an affiliate of
its direct party enters receivership of insolvency proceedings is
unlikely to prevail in court unless there is clear and convincing
evidence that the exercise of the default right against a covered
entity is not related to the insolvency or resolution proceeding. The
requirement therefore should discourage the impermissible exercise of
default rights without prohibiting the exercise of all default rights.
Moreover, the burden of proof requirement should not discourage the
exercise of default rights after or in response to a failure to satisfy
a creditor protection provision (e.g., direct default rights); such a
failure should be easily evidenced, even under a heightened burden of
proof, such that clarification through court proceedings should not be
necessary.
Agency transactions. In addition to entering into QFCs as
principals, GSIBs may engage in QFCs as agent for other principals. For
example, a GSIB subsidiary may enter into a master securities lending
arrangement with a foreign bank as agent for a U.S.-based pension fund.
The GSIB would document its role as agent for the pension fund, often
through an annex to the master agreement, and would generally provide
to its customer (the principal party) a securities replacement
guarantee or indemnification for any shortfall in collateral in the
event of the default of the foreign bank.\203\ A covered entity may
also enter into a QFC as principal where there is an agent acting on
its behalf or on behalf of its counterparty.
---------------------------------------------------------------------------
\203\ The definition of QFC under Title II of the Dodd-Frank
Act, which is adopted in the final rule, includes security
agreements and other credit enhancements as well as master
agreements (including supplements). 12 U.S.C. 5390(c)(8)(D); see
also final rule Sec. 252.81.
---------------------------------------------------------------------------
This proposal would have applied to a covered QFC regardless of
whether the covered entity or the covered entity's direct counterparty
is acting as a principal or as an agent. Sections 252.83 and 252.84 of
the proposal did not distinguish between agents and principals with
respect to default rights or transfer restrictions applicable to
covered QFCs. Under the proposal, section 252.83 would have limited
default rights and transfer restrictions that the principal and its
agent may have against a covered entity consistent with the U.S.
Special Resolution Regimes.\204\ Section 252.84 of the proposed rule
would have ensured that, subject to the enumerated creditor
protections, neither the agent nor the principal could exercise cross-
default rights under the covered QFC against the covered entity based
on the resolution of an affiliate of the covered entity.\205\
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\204\ See proposed rule Sec. 252.83(a)(3).
\205\ See proposed rule Sec. Sec. 252.84(a)(3), 252.84(d).
---------------------------------------------------------------------------
Commenters argued that the provisions of sections 252.83 and 252.84
that relate to transactions entered into by the covered entity as agent
should exclude QFCs where the covered entity or its affiliate does not
have any liability (including contingent liability) under or in
connection with the contract, or any payment or delivery obligations
with respect thereto. Commenters also argued that the proposed agent
provisions should not apply to circumstances where the covered entity
acts as agent for a counterparty whose transactions are excluded from
the requirements of the rule.\206\ Commenters provided as an example
where an agent simply executes an agreement on behalf of the principal
but bears no liability thereunder, such as where an investment manager
signs an agreement on behalf of a client. Commenters noted that such
agreements could contain events of default relating to the
[[Page 42908]]
insolvency of the agent or an affiliate of the agent but that such
default rights would be difficult to track and that close-out of such
QFCs would not result in any loss or liquidity impact to the agent.
Rather, early termination under the agreements would subject the cash
and securities of the principals--not the agent--to realization and
liquidation. Therefore, the agent would not be exposed to the liquidity
and asset fire sale risks the proposal was intended to address.
---------------------------------------------------------------------------
\206\ Commenters argued this should be the case even where an
agent has entered an umbrella master agreement on behalf of more
than one principal, but only with respect to the contract of any
principals that are excluded counterparties.
---------------------------------------------------------------------------
Commenters contended that the requirement to conform QFCs with all
affiliates of a counterparty when an agent is acting on behalf of the
counterparty would be particularly burdensome, as the agent may not
have information about the counterparty's affiliates or their contracts
with covered entities. Commenters also requested clarification that
conformance is not required of contracts between a covered entity as
agent on behalf of a non-U.S. affiliate of a foreign GSIB that would
not be a covered entity under the proposal, since default rights
related to the non-U.S. operations of foreign GSIBs are not the focus
of the rule and do not bear a sufficient connection to U.S. financial
stability to warrant the burden and cost of compliance.
One commenter also urged that securities lending authorization
agreements (SLAAs) should also be exempt from the rule. The commenter
explained that SLAAs are banking services agreements that establish an
agency relationship with the lender of securities and an agent and may
be considered credit enhancements for securities lending transactions
(and therefore QFCs) because the SLAAs typically require the agent to
indemnify the lender for any shortfall between the value of the
collateral and the value of the securities in the event of a borrower
default. The commenter explained that SLAAs typically do not contain
provisions that may impede the resolution of a GSIB, but may contain
termination rights or contractual restrictions on assignability.
However, the commenter argued that the beneficiaries under SLAAs lack
the incentive to contest the transfer of the SLAA to a bridge
institution in the event of GSIB insolvency.
To respond to concerns raised by commenters, the agency provisions
of the proposed rule have been modified in the final rule. The final
rule provides that a covered entity does not become a party to a QFC
solely by acting as agent to a QFC.\207\ Therefore, an in-scope QFC
would not be a covered QFC solely because a covered entity was acting
as the agent of a principal with respect to the QFC.\208\ For example,
the final rule would not require a covered entity to conform a master
securities lending arrangement (or the transactions under the
agreement) to the requirements of the final rule if the only
obligations of the covered entity under the agreement are to act as an
agent on behalf of one or more principals. This modification should
address many of the concerns raised by commenters.
---------------------------------------------------------------------------
\207\ See final rule Sec. 252.82(e)(1).
\208\ Such a QFC would nonetheless be a covered QFC with respect
to a principal that also was a covered entity. In response to
comments, the Board notes that covered entities do not include non-
U.S. subsidiaries of a foreign GSIB.
---------------------------------------------------------------------------
The final rule does not specifically exempt SLAAs because the
agreements provide the beneficiaries with contractual rights that may
hinder the orderly resolution of a GSIB and because it is unclear how
such beneficiaries would act in response to the failure of their agent.
More generally, the final rule does not exempt a QFC with respect to
which an agent also acts in another capacity, such as guarantor.
Continuing the example regarding the covered entity acting as agent
with respect to a master securities lending agreement, if the covered
entity also provided a SLAA that included the typical indemnification
provision discussed above, the agency exemption of the final rule would
not exclude the SLAA but would still exclude the master securities
lending agreement. This is because the covered entity is acting solely
as agent with respect to the master securities lending agreement but is
acting as agent and guarantor with respect to the SLAA. However, SLAAs
would be exempted under the final rule to the extent that they are not
``in-scope QFCs'' or otherwise meet the exemptions for covered QFCs of
the final rule.
Enforceability. Commenters also requested that the final rule
should clarify that obligations under a QFC would still be enforceable
even if its terms do not comply with the requirements of the final
rule, similar to assurances provided in respect of the UK rule and
German legislation. The enforceability of a contract is beyond the
scope of this rule.
Interaction with Other Regulatory Requirements. Certain commenters
requested clarification that amending covered QFCs as required by this
final rule should not trigger other regulatory requirements for covered
entities, such as the swap margin requirements issued by the Board,
other prudential regulators (the OCC, FDIC, Farm Credit Administration,
and Federal Housing Financing Agency), and the U.S. Commodity Futures
Trading Commission (CFTC). In particular, commenters urged that
amending a swap to conform to this final rule should not jeopardize the
status of the swap as a legacy swap for purposes of the swap margin
requirements for non-cleared swaps. These issues are outside the scope
of this rule as they relate to the requirements of another rule issued
by the Board jointly with the other prudential regulators, as well as a
rule issued by the CFTC. As commenters pointed out, addressing such
issues may require consultation with the other prudential regulators as
well as the CFTC and the U.S. Securities and Exchange Commission to
determine the impact of the amendments required by this final rule for
purposes of the regulatory requirements under Title VII. However, as
the proposal noted, the Board is considering an amendment to the
definition of ``eligible master netting agreement'' to account for the
restrictions on covered QFCs and is consulting with the other
prudential regulators and the CFTC on this aspect of the final
rule.\209\ The Board does not expect that compliance with this final
rule would trigger the swap margin requirements for non-cleared swaps.
---------------------------------------------------------------------------
\209\ See 81 FR 29169, 29186 (May 11, 2016).
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Compliance with the Universal and U.S. Protocols. The final rule,
like the proposal, allows covered entities to conform covered QFCs to
the requirements of the proposed rule through adherence to the
Universal Protocol.\210\ The two primary operative provisions of the
Universal Protocol are Section 1 and Section 2. Under Section 1,
adhering parties essentially ``opt in'' to the U.S. Special Resolution
Regimes and certain other special resolution regimes. Therefore,
Section 1 is generally responsive to the concerns addressed in section
252.83 of the final rule. Under Section 2, adhering parties essentially
forego, subject to the creditor protections of Section 2, cross-default
rights and transfer restrictions on affiliate credit enhancements.
Therefore, Section 2 is generally responsive to the concerns addressed
in section 252.84 of the final rule.
---------------------------------------------------------------------------
\210\ See final rule Sec. 252.85(a).
---------------------------------------------------------------------------
The proposal noted that, while the scope of the stay-and-transfer
provisions of the Universal Protocol are narrower than the stay-and-
transfer provisions that would have been required under the proposal
and the Universal Protocol provides a number of creditor protection
provisions that would not otherwise have been available under the
proposal, the Universal Protocol includes a
[[Page 42909]]
number of desirable features that the proposal lacked. The proposal
explained that ``when an entity (whether or not it is a covered entity)
adheres to the [Universal] Protocol, it necessarily adheres to the
[Universal] Protocol with respect to all covered entities that have
also adhered to the Protocol rather than one or a subset of covered
entities (as the proposal may otherwise permit). . . . This feature
appears to allow the [Universal] Protocol to address impediments to
resolution on an industry-wide basis and increase market certainty,
transparency, and equitable treatment with respect to default rights of
non-defaulting parties.'' \211\ This feature is referred to as
``universal adherence.'' The proposal explained that other favorable
features of the Universal Protocol included that it amends all existing
transactions of adhering parties, does not provide the counterparty
with default rights in addition to those provided under the underlying
QFC, applies to all QFCs, and includes resolution under bankruptcy as
well as U.S. and certain non-U.S. Special Resolution Regimes. Because
the features of the Universal Protocol, considered together, appeared
to increase the likelihood that the resolution of a GSIB under a range
of scenarios could be carried out in an orderly manner, the proposal
stated that QFCs amended by the Universal Protocol would have been
consistent with the proposal, notwithstanding differences from section
252.84 of the proposal.
---------------------------------------------------------------------------
\211\ 81 FR 29169, 29182-83 (May 11, 2016).
---------------------------------------------------------------------------
Commenters generally supported the proposal's provisions to allow
covered entities to comply with the requirements of the proposed rule
through adherence to the Universal Protocol. For the reasons discussed
above and in the proposal, the final rule continues to allow covered
entities to comply with the rule through adherence to the Universal
Protocol and makes other modifications to the proposal to address
comments.
A few commenters requested that the final rule clarify two
technical aspects of adherence to the Universal Protocol. These
commenters requested confirmation that adherence to the Universal
Protocol would also satisfy the requirements of section 252.83. The
commenters also requested confirmation that QFCs that incorporate the
terms of the Universal Protocol by reference also would be deemed to
comply with the terms of the proposed alternative method of
compliance.\212\ By clarifying section 252.85(a), the final rule
confirms that adherence to the Universal Protocol is deemed to satisfy
the requirements of section 252.83 of the final rule (as well as
section 252.84) and that conformance of a covered QFC through the
Universal Protocol includes incorporation of the terms of the Universal
Protocol by reference by protocol adherents. This clarification also
applies to the U.S. Protocol, discussed below.
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\212\ ``As between two Adhering Parties, the [Universal
Protocol] only amends agreements between the Adhering Parties that
have been entered into as of the date that the Adhering Parties
adhere (as well as any subsequent transactions thereunder), but it
does not amend agreements that Adhering Parties enter into after
that date. . . . If Adhering Parties wish for their future
agreements to be subject to the terms of the [Universal Protocol] or
a Jurisdictional Module Protocol under the ISDA JMP, it is expected
that they would incorporate the terms of the [relevant protocol] by
reference into such agreements.'' Letter to Robert deV. Frierson,
Secretary, Board of Governors of the Federal Reserve System, from
Katherine T. Darras, ISDA General Counsel, The International Swaps
and Derivatives Association, Inc., at 8-9 (Aug. 5, 2016). This
commenter noted that incorporation by reference was consistent with
the proposal and asked that the text of the rule be clarified. Id.
at 9.
---------------------------------------------------------------------------
One commenter indicated that many non-covered entity counterparties
do not have ISDA master agreements for physically-settled forward and
commodity contracts and, therefore, compliance with the rule's
requirements through adherence to the Universal Protocol would entail
substantial time and educational effort. As in the proposal, the final
rule simply permits adherence to the Universal Protocol as one method
of compliance with the rule's requirements, and parties may meet the
rule's requirements through bilateral negotiation, if they choose.
Moreover, the Securities Financing Transaction Annex and Other
Agreements Annex of the Universal Protocol, which are specifically
identified in the proposed and final rule, are designed to amend QFCs
that are not ISDA master agreements.
Many commenters argued that the final rule should also allow
compliance with the rule through a yet-to-be-created ``U.S.
Jurisdictional Module to the ISDA Resolution Stay Jurisdictional
Modular Protocol'' (an ``approved U.S. JMP'') that is generally the
same but narrower in scope than the Universal Protocol.\213\ Many non-
GSIB commenters argued that they were not involved with the drafting of
the Universal Protocol and that an approved U.S. JMP would create a
level playing field between those that were involved in the drafting
and those that were not. In general, commenters identified two aspects
of the Universal Protocol that they argued should be narrowed in the
approved U.S. JMP: The scope of the special resolution regimes and the
universal adherence feature of the Universal Protocol.
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\213\ Commenters argued that approval of the approved U.S. JMP
should not require satisfaction of the administrative requirements
of section 252.85(b)(3), since the Board has already conducted that
analysis in deciding to provide a safe harbor for the Universal
Protocol.
---------------------------------------------------------------------------
With respect to the scope of the special resolution regimes of the
Universal Protocol, commenters' concern focused on the special
resolution regimes of ``Protocol-eligible Regimes.'' Some commenters
also expressed concern with the scope of ``Identified Regimes'' of the
Universal Protocol.
The Universal Protocol defines ``Identified Regimes'' as the
special resolution regimes of France, Germany, Japan, Switzerland, and
the United Kingdom, as well as the U.S. Special Resolution Regimes. The
Universal Protocol defines ``Protocol-eligible Regimes'' as resolution
regimes of other jurisdictions specified in the protocol that satisfies
the requirements of the Universal Protocol. The Universal Protocol
provides a ``Country Annex,'' which is a mechanism by which individual
adherents to the Universal Protocol may agree that a specific
jurisdiction satisfies the requirements of a ``Protocol-eligible
Regime.'' The Universal Protocol referred to in the proposal did not
include any Country Annex for any Protocol-eligible Regime.\214\
---------------------------------------------------------------------------
\214\ The proposal defined the Universal Protocol as the ``ISDA
2015 Universal Resolution Stay Protocol, including the Securities
Financing Transaction Annex and Other Agreements Annex, published by
the International Swaps and Derivatives Association, Inc., as of May
3, 2016, and minor or technical amendments thereto.'' See proposed
rule Sec. 252.85(a). As of May 3, 2016, ISDA had not published any
Country Annex for a Protocol-eligible Regime and such publication
would not be a minor or technical amendment to the Universal
Protocol. Consistent with the proposal, the final rule does not
define the Universal Protocol to include any Country Annex. However,
the final rule does not penalize adherence to any Country Annex. A
covered QFC that is amended by the Universal Protocol--but not a
Country Annex--will be deemed to conform to the requirements of the
final rule. In addition, a covered QFC that is amended by the
Universal Protocol--including one or more Country Annexes--is also
deemed to conform to the requirements of the final rule. See final
rule Sec. 252.85(a)(2).
---------------------------------------------------------------------------
Commenters requested the final rule include a safe harbor for an
approved U.S. JMP that does not include Protocol-eligible Regimes.
Commenters argued that many counterparties may not be able to adhere to
the Universal Protocol because they would not be able to adhere to a
Protocol-eligible Regime in the absence of law or regulation mandating
such adherence, as it would
[[Page 42910]]
force counterparties to give up default rights in jurisdictions where
that is not yet legally required.\215\ In support of their argument,
commenters cited their fiduciary duties to act in the best interests of
their clients or shareholders. Commenters also argued that an approved
U.S. JMP should not include Identified Regimes and noted that the other
Identified Regimes have already adopted measures to require contractual
recognition of their special resolution regimes.\216\
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\215\ The Protocol-eligible Regime requirements of the Universal
Protocol do not include a requirement that a law or regulation, such
as the final rule, require parties to contractually opt in to the
regime.
\216\ One commenter requested clarification that a QFC of a
covered entity with a non-U.S. credit support provider for the
covered entity complies with the requirements of the final rule to
the extent the covered entity has adhered to the relevant
jurisdictional modular protocol for the jurisdiction of the non-U.S.
credit support provider. The jurisdictional modular protocols for
other counties do not satisfy the requirements of the final rule.
---------------------------------------------------------------------------
With respect to the universal adherence feature of the Universal
Protocol, commenters argued that universal adherence imposed
significant monitoring burden since new adherents may join the
Universal Protocol at any time. To address this concern, some
commenters requested that an approved U.S. JMP allow a counterparty to
adhere on a firm-by-firm or entity-by-entity basis. Other commenters
suggested, or supported approval of, an approved U.S. JMP in which a
counterparty would adhere to all current covered entities under the
final rule (to be identified on a ``static list'') and would adhere to
new covered entities on an entity-by-entity basis. This static list,
commenters argued, would retain the ``universal adherence mechanics''
of the Universal Protocol and allow market participants to fulfill due
diligence obligations related to compliance. Commenters also argued
that universal adherence would be overbroad because the Universal
Protocol could amend QFCs to which a covered entity or excluded bank
was not a party. Certain commenters argued that adhering with respect
to any counterparty would also be inconsistent with their fiduciary
duties.
In response to comments and to further facilitate compliance with
the rule, the final rule provides that covered QFCs amended through
adherence to the Universal Protocol or a new (and separate) protocol
(the ``U.S. Protocol'') would be deemed to conform the covered QFCs to
the requirements of the final rule.\217\ The U.S. Protocol may differ
from the Universal Protocol in certain respects, as discussed below,
but otherwise must be substantively identical to the Universal
Protocol.\218\ Therefore, the reasons for deeming covered QFCs amended
by the Universal Protocol to conform to the final rule, discussed above
and in the proposal, apply to the U.S. Protocol.
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\217\ The final rule also provides that the Board may determine
otherwise based on specific facts and circumstances. See final rule
Sec. 252.85(a).
\218\ Commenters expressed support for having the U.S. Protocol
apply to both existing and future QFCs. One commenter requested that
an approved U.S. JMP should apply only to QFCs governed by non-U.S.
law because the U.S. Special Resolution Regimes already apply to
QFCs governed by U.S. law. As discussed above, the final rule does
not exempt a QFC solely because the QFC explicitly states that is
governed by U.S. law. Moreover, such a limited application would
reduce the desirable additional benefits of the Universal Protocol,
discussed above.
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Consistent with the proposal \219\ and requests by commenters, the
U.S. Protocol may limit the application of the provisions the Universal
Protocol identifies as Section 1 and Section 2 to only covered entities
and excluded banks.\220\ As requested by commenters, this limitation on
the scope of the U.S. Protocol may ensure that the U.S. Protocol would
only amend covered QFCs under this final rule or the substantively
identical final rules expected to be issued by the OCC and FDIC and not
also QFCs outside the scope of the agencies' final rules (i.e., QFCs
between parties that are not covered entities or excluded banks).
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\219\ The proposal explained that a ``jurisdictional module for
the United States that is substantively identical to the [Universal]
Protocol in all respects aside from exempting QFCs between adherents
that are not covered entities or covered banks would be consistent
with the current proposal.'' 81 FR 29169, 29181 n.106 (May 11,
2016).
\220\ The final rule does not require the U.S. Protocol to
retain the same section numbering as the Universal Protocol. The
final rule allows the U.S. protocol to have minor and technical
differences from the Universal Protocol. See final rule Sec.
252.85(a)(3)(ii)(F).
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The final rule also provides that the U.S. Protocol is required to
include the U.S. Special Resolution Regimes and the other Identified
Regimes but is not required to include Protocol-eligible Regimes.\221\
As noted above, the Universal Protocol, as defined in the proposal, did
not include any Country Annex for a Protocol-eligible Regime; the only
special resolution regimes specifically identified in the Universal
Protocol, as defined in the proposal, were the U.S. Special Resolution
Regimes and the other Identified Regimes. As explained in the proposal,
inclusion of the Identified Regimes should help facilitate the
resolution of a GSIB across a broader range of circumstances.\222\
Inclusion of the Identified Regimes in the U.S. Protocol also should
support laws and regulations similar to the final rule and help
encourage GSIB entities in the United States to adhere to a protocol
that includes all Identified Regimes. However, the final rule does not
require the U.S. Protocol to include Protocol-eligible Regimes,
including definitions and adherence mechanisms related to Protocol-
eligible Regimes.\223\ Inclusion of only the Identified Regimes in the
U.S. Protocol, considered in light of the other benefits to the
resolution of GSIBs provided by the Universal Protocol and U.S.
Protocol as well as commenters' concerns with potential adherence to
Protocol-eligible Regimes, should sufficiently advance the objective of
the final rule to increase the likelihood that a resolution of a GSIB
could be carried out in an orderly manner under a range of scenarios.
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\221\ See final rule Sec. 252.85(a)(3)(ii)(A). The U.S.
Protocol is likewise not required to include definitions and
adherence mechanisms related to Protocol-eligible Regimes. The final
rule allows the U.S. Protocol to include minor and technical
differences from the Universal Protocol and, similarly, differences
necessary to conform the U.S. Protocol to the substantive
differences allowed or required from the Universal Protocol. See
final rule Sec. 252.85(a)(3)(ii)(E).
\222\ 81 FR 29169, 29183 (May 11, 2016).
\223\ See final rule Sec. 252.85(a)(3)(ii)(A).
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The U.S. Protocol does not permit parties to adhere on a firm-by-
firm or entity-by-entity basis because such adherence mechanisms
requested by commenters would obviate one of the primary benefits of
the Universal Protocol: Universal adherence. Similarly, the final rule
does not permit adherence to a ``static list'' of all current covered
entities, which other commenters requested.\224\ Although the static
list would initially provide for universal adherence, the static list
would not provide for universal adherence with respect to entities that
became covered entities after the static list was finalized. To help
ensure that the additional creditor protections of the Universal
Protocol and U.S. Protocol continue to be justified, both protocols
must ensure that the desirable features of the protocols, including
universal adherence, continue to be present as GSIBs acquire
subsidiaries with existing QFCs and existing organizations become
designated as GSIBs.
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\224\ The final rule, however, does not prohibit the creation of
a dynamic list identifying of all current ``Covered Parties,'' as
would be defined in the U.S. Protocol, to facilitate due diligence
and provide additional clarity to the market. See final rule Sec.
252.85(a)(2)(ii)(E) (allowing minor and technical differences from
the Universal Protocol).
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The final rule also addresses provisions that allow an adherent to
elect that Section 1 and/or Section 2 of the Universal Protocol do not
apply to the adherent's contracts.\225\ The Universal Protocol refers
to these
[[Page 42911]]
provisions as ``opt-outs.'' The proposal explained that adherence to
the Universal Protocol was an alternative method of compliance with the
proposed rule and that covered QFCs that were not amended by the
Universal Protocol must otherwise conform to the proposed rule. In
other words, the proposal would have required that a covered QFC be
conformed regardless of the method the covered entity and counterparty
chooses to conform the QFC.\226\
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\225\ Section 4(b) of the Universal Protocol.
\226\ Under the final rule, if an adherent to the Universal
Protocol or U.S. Protocol exercises an available opt-out, covered
entities with covered QFCs affected by the exercise would be
required to otherwise conform the covered QFCs to the requirements
of the rule.
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Consistent with the basic purposes of the proposed and final rules,
the U.S. Protocol requires that opt-outs exercised by its adherents
will only be effective to the extent that the affected covered QFCs
otherwise conform to the requirements of the final rule. Therefore, the
U.S. Protocol allows counterparties to exercise available opt-out
rights in a manner that also allows covered entities to ensure that
their covered QFCs continue to conform to the requirements of the rule.
The final rule also provides that, under the U.S. Protocol, the
opt-out in Section 4(b)(i)(A) of the attachment to the Universal
Protocol (Sunset Opt-out) \227\ must not apply with respect to the U.S.
Special Resolution Regimes because the opt-out is no longer relevant
with respect to the U.S. Special Resolution Regimes. This final rule,
along with the substantively identical rules expected to be issued by
the FDIC and OCC, should prevent exercise of the Sunset Opt-out with
respect to the U.S. Special Resolution Regimes under the Universal
Protocol. Inapplicability of this opt-out with respect to U.S. Special
Resolution Regimes in the U.S. Protocol should provide additional
clarity to adherents that the U.S. Protocol will continue to provide
for universal adherence after January 1, 2018.
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\227\ See Section 4(b)(i)(A) of the Universal Protocol.
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The final rule also expressly addresses a provision in the
Universal Protocol that concerns the client-facing leg of a cleared
transaction. As discussed above, the final rule, like the proposal,
does not exempt the client-facing leg of a cleared transaction.
Therefore, the U.S. Protocol must not include the exemption in Section
2 of the Universal Protocol regarding the client-facing leg of the
transaction.\228\
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\228\ Section 2 of the Universal Protocol provides an exemption
for any client-facing leg of a cleared transaction. See Section 2(k)
of the Universal Protocol and the definition of ``Cleared Client
Transaction.'' The final rule does not amend the proposal's
treatment of QFCs that are ``Cleared Client Transactions'' under the
Universal Protocol, but requires that the provisions of that section
must not apply with respect to the U.S. Protocol. See final rule
Sec. 252.85(a)(3)(ii)(D).
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F. Process for Approval of Enhanced Creditor Protections (Section
252.85 of the Final Rule)
As discussed above, the restrictions of the final rule leaves many
creditor protections that are commonly included in QFCs unaffected. The
final rule also allows any covered entity to submit to the Board a
request to approve as compliant with the rule one or more QFCs that
contain additional creditor protections--that is, creditor protections
that would be impermissible under the restrictions set forth
above.\229\ A covered entity making such a request would be required to
provide an analysis of the contractual terms for which approval is
requested in light of a range of factors that are set forth in the
final rule and intended to facilitate the Board's consideration of
whether permitting the contractual terms would be consistent with the
proposed restrictions.\230\ The Board also expects to consult with the
FDIC and OCC during its consideration of such a request.
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\229\ See final rule Sec. 252.85(b).
\230\ Final rule Sec. 252.85(d)(1)-(10).
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The first two factors concern the potential impact of the requested
creditor protections on GSIB resilience and resolvability. The next
four concern the scope of the final rule: Adoption on an industry-wide
basis, coverage of existing and future transactions, coverage of one or
multiple QFCs, and coverage of some or all covered entities. Creditor
protections that may be applied on an industry-wide basis may help to
ensure that impediments to resolution are addressed on a uniform basis,
which could increase market certainty, transparency, and equitable
treatment. Creditor protections that apply broadly to a range of QFCs
and covered entities would increase the chances that all of a GSIB's
QFC counterparties would be treated the same way during a resolution of
that GSIB and may improve the prospects for an orderly resolution of
that GSIB. By contrast, proposals that would expand counterparties'
rights beyond those afforded under existing QFCs would conflict with
the proposal's goal of reducing the risk of mass unwinds of GSIB QFCs.
The final rule also includes three factors that focus on the creditor
protections specific to supported parties. The Board may weigh the
appropriateness of additional protections for supported QFCs against
the potential impact of such provisions on the orderly resolution of a
GSIB.
In addition to analyzing the request under the enumerated factors,
a covered entity requesting that the Board approve enhanced creditor
protections would be required to submit a legal opinion stating that
the requested terms would be valid and enforceable under the applicable
law of the relevant jurisdictions, along with any additional relevant
information requested by the Board.\231\
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\231\ See final rule Sec. 252.85(b)(3)(ii)-(iii).
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Under the final rule, the Board could approve a request for an
alternative set of creditor protections if the terms of the QFC, as
compared to a covered QFC containing only the limited creditor
protections permitted by the final rule, would prevent or mitigate
risks to the financial stability of the United States that could arise
from the failure of a GSIB and would protect the safety and soundness
of bank holding companies and state member banks to at least the same
extent.\232\ Once approved by the Board, enhanced creditor protections
could be used by other covered entities (in addition to the covered
entity that submitted the request for Board approval), as appropriate.
The request-and-approval process would improve flexibility by allowing
for an industry-proposed alternative to the set of creditor protections
permitted by the final rule while ensuring that any approved
alternative would serve the final rule's policy goals to at least the
same extent as a covered QFC that complies fully with the final rule.
---------------------------------------------------------------------------
\232\ See final rule Sec. 252.85(c).
---------------------------------------------------------------------------
Commenters requested that this approval process be made less
burdensome and more flexible and urged for additional clarifications on
the process for submitting and approving such requests (e.g., whether
approvals would be published in the Federal Register). For example,
commenters requested the final rule include a reasonable timeline
(e.g., 180 days) by which the Board would approve or deny a request.
Certain commenters urged that counterparties and trade groups, in
addition to covered entities, should be permitted to make such
requests. One commenter noted that the proposal's approval process
would have created a free-rider problem, where parties that submit
enhanced creditor protection conditions for Board approval bear the
full cost of learning which remedies are available for creditors while
other parties will gain that information for free. Commenters contended
that the provision requiring a ``written legal opinion verifying the
proposed
[[Page 42912]]
provisions and amendments would be valid and enforceable under
applicable law of the relevant jurisdictions'' should be eliminated as
unnecessary.\233\ Additionally, commenters also urged that the
provision should be broadened to allow approvals of provisions not
directly related to enhanced creditor protections.
---------------------------------------------------------------------------
\233\ One commenter also suggested permitting amendments to QFCs
to be accomplished through a confirmation document for a new
agreement or by email instead of a formal amendment of the QFC
signed by the parties. The final rule does not prescribe a specific
method for amending covered QFCs.
---------------------------------------------------------------------------
The Board has clarified that the Board could approve an alternative
proposal of additional creditor protections as compliant with sections
252.83 and 252.84 of the final rule, but has not otherwise modified
these provisions of the proposal in response to changes requested by
commenters. The provisions contain flexibility and guidance on the
process for submitting and approving enhanced creditor protections. The
final rule directly places requirements only on covered entities, and
thus only covered entities are eligible to submit requests pursuant to
these provisions. In response to commenters' concerns, the Board notes
that the final rule does not prevent multiple covered entities from
presenting one request and does not prevent covered entities from
seeking the input of counterparties when developing a request. The
final rule does not provide a maximum time to review proposals because
proposals could vary greatly in complexity and novelty. The final rule
also maintains the provision requiring a written legal opinion, which
helps ensure that proposed provisions are valid and enforceable under
applicable law. The final rule does not expand the approval process
beyond additional creditor protections; however, revisions to aspects
of the final rule may be made through the rulemaking process.
III. Transition Periods
Under the proposal, the rule would have required compliance on the
first day of the first calendar quarter beginning at least one year
after the issuance of the final rule, which the proposal referred to as
the effective date.\234\ A number of commenters urged the Board to
adopt a phased-in approach to compliance that would extend the
compliance deadline for covered QFCs with certain types of
counterparties in order to allow time for necessary client outreach and
education, especially for non-GSIB counterparties that may be
unfamiliar with the Universal Protocol or the final rule's
requirements. These commenters contended that the original compliance
period of one year should be limited to counterparties that are banks,
broker-dealers, swap dealers, security-based swap dealers, major swap
participants, and major security-based swap participants. These
commenters urged that the compliance period for QFCs with asset
managers, commodity pools, private funds, and other entities that are
predominantly engaged in activities that are financial in nature within
the meaning of section 4(k) of the BHC Act should be extended for six
months after the date of the original compliance period identified in
the proposed rule. Finally, these commenters argued that the compliance
period for QFCs with all other counterparties should be extended for 12
months after the date of the original compliance period identified in
the proposed rule as these counterparties are likely to be least
familiar with the requirements of the final rule.
---------------------------------------------------------------------------
\234\ See proposed rule Sec. 252.82(b). Under section 302(b) of
the Riegle Community Development and Regulatory Improvement Act of
1994, new Board regulations that impose requirements on insured
depository institutions generally must ``take effect on the first
day of a calendar quarter which begins on or after the date on which
the regulations are published in final form.'' 12 U.S.C. 4802(b).
---------------------------------------------------------------------------
One commenter suggested that the rule should take effect no sooner
than one year from the date that an approved U.S. JMP is published and
available for adherence, including any additional time it might take to
seek the Board's approval of it. Certain commenters requested that the
compliance deadline for covered QFCs entered into by an agent on behalf
of a principal be extended by six months as well. Other commenters,
however, cautioned against an approach that would impose different
deadlines with respect to different classes of QFCs, as opposed to
counterparty types, since the main challenge in connection with the
remediation is the need for outreach to and education of
counterparties. These commenters contended that once a counterparty has
become familiar with the requirements of the rule and the terms of the
required amendments, it would be more efficient to remediate all
covered QFCs with the counterparty at the same time.
A number of commenters also requested that the Board confirm that
entities acquired by a GSIB, and thereby become new covered entities,
have until the first day of the first calendar quarter immediately
following one year after becoming covered entities to conform their
existing QFCs. Commenters argued that this would allow the GSIB to
conform existing QFCs in an orderly fashion without impairing the
ability of covered entities to engage in corporate activities. These
commenters also requested clarification that, during that conformance
period, affiliates of covered entities would not be prohibited from
entering into new transactions or QFCs with counterparties of the newly
acquired entity if the existing covered entities otherwise comply with
the rule's requirements. Some commenters urged the Board to exclude
existing contracts from the final rule's requirements and only apply
the rule on a prospective basis.
The effective date for the final rule is 60 days following
publication in the Federal Register. However, in order to reduce the
compliance burden of the final rule, the Board has adopted a phased-in
compliance schedule, as requested by commenters. The final rule
provides that a covered entity must conform a covered QFC to the
requirements of this final rule by the first day of the calendar
quarter immediately following one year from the effective date of this
subpart with respect to covered QFCs with other covered entities and
excluded banks (referred to in this discussion as the ``first
compliance date'').\235\ This provision allows the counterparties that
should be most familiar with the requirements of the final rule over
one year to conform with the rule's requirements. Moreover, this is a
relatively small number of counterparties that would need to modify
their QFCs in the first year following the effective date of the final
rule, and many covered entities and excluded banks with covered QFCs
have already adhered to the Universal Protocol.
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\235\ See final rule Sec. 252.82(f)(1)(i). The definition of
covered QFC of the final rule has been revised to make clear that,
consistent with the proposal, a covered QFC is a QFC that the
covered entity becomes a party to on or after the first day of the
calendar quarter immediately following one year from the effective
date of this subpart. See final rule Sec. 252.82(c). As discussed
above, a covered entity's in-scope QFC that is entered into before
this date may also be a covered QFC if the covered entity or any
affiliate that is a covered entity or excluded bank also becomes a
party to a QFC with the same counterparty or a consolidated
affiliate of the same counterparty on or after the first compliance
date. See id.
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The final rule provides additional time for compliance with the
requirements for other types of counterparties. In particular, for
other types of financial counterparties \236\ (other than small
financial institutions) \237\, the final rule provides
[[Page 42913]]
approximately 18 months from the effective date of the final rule for
compliance with its requirements, as requested by commenters.\238\ For
community banks and other non-financial counterparties, the final rule
provides approximately two years from the effective date of the final
rule for compliance with its requirements, as requested by
commenters.\239\ Adopting a phased-in compliance approach based on the
type (and, in some cases, size) of the counterparty will allow market
participants time to adjust to the new requirements and make required
changes to QFCs in an orderly manner. It will also give time for
development of the U.S. Protocol or any other protocol that would meet
the requirements of the final rule.
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\236\ See final rule Sec. 252.81 (defining ``financial
counterparty'').
\237\ The final rule defines small financial institution as an
insured bank, insured savings association, farm credit system
institution, or credit union with assets of $10,000,000,000 or less.
See final rule Sec. 252.81.
\238\ See final rule Sec. 252.82(f)(1)(ii).
\239\ See final rule Sec. 252.82(f)(1)(iii).
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The Board is giving this additional time for compliance to respond
to concerns raised by commenters. The Board encourages covered entities
to start planning and outreach efforts early in order to come into
compliance with the rule on the time frames provided. The Board
believes that this additional time for compliance should also address
concerns raised by commenters regarding the burden of conforming
existing contracts by allowing firms additional time to conform all
covered QFCs to the requirements of the final rule.
Although the phased-in compliance period does not contain special
rules related to acting as an agent as requested by certain commenters,
the rule has been modified as described above to clarify that a covered
entity does not become a party to a QFC solely by acting as agent with
respect to the QFC.\240\
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\240\ See final rule Sec. 252.82(e)(1).
---------------------------------------------------------------------------
Entities that are covered entities when the final rule is effective
would be required to comply with the requirements of the final rule
beginning on the first compliance date. Thus, a covered entity would be
required to ensure that covered QFCs entered into on or after the first
compliance date comply with the rule's requirements but would be given
more time to conform such covered QFCs with entities that are not
covered entities or excluded banks.\241\ Moreover, a covered entity
would be required to bring an in-scope QFC entered into prior to the
first compliance date into compliance with the rule no later than the
applicable date of the tiered compliance dates (discussed above) if the
covered entity or an affiliate (that is also a covered entity or
excluded bank) enters into a new covered QFC with the counterparty to
the pre-existing covered QFC or a consolidated affiliate of the
counterparty on or after the first compliance date.\242\ (Thus, a
covered entity would not be required to conform a pre-existing QFC if
that covered entity and its covered entity and excluded bank affiliates
do not enter into any new QFCs with the same counterparty or its
consolidated affiliates on or after the first compliance date.)
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\241\ See final rule Sec. Sec. 252.82(c)(1), 252.82(f)(1).
\242\ See id.
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In addition, an entity that becomes a covered entity after the
effective date of the final rule (a ``new covered entity'' for purposes
of this preamble) generally has the same period of time to comply as an
entity that is a covered entity on the effective date (i.e., compliance
will phase in over a two-year period based on the type of
counterparty).\243\ The final rule also clarifies that a covered QFC,
with respect to a new covered entity, means an in-scope QFC that the
new covered entity becomes a party to (1) on the date the covered
entity first becomes a covered entity, and (2) before that date, if the
covered entity or one of its affiliates that is a covered entity or
exempt bank also enters, executes, or otherwise becomes a party to a
QFC with the same counterparty or a consolidated affiliate of the
counterparty after that date.\244\ Under the final rule, a company that
is a covered entity on the effective date of the final rule (an
``existing covered entity'' for purposes of this preamble) and becomes
an affiliate of a new covered entity generally must conform any
existing but non-conformed in-scope QFC that the existing covered
entity continues to have with a counterparty after the applicable
initial compliance date by the date the new covered entity enters a QFC
with the same counterparty (or any of its consolidated affiliates) or
within a reasonable period thereafter. Acquisitions of new entities are
planned in advance and should include preparing to comply with
applicable laws and regulations.
---------------------------------------------------------------------------
\243\ See final rule Sec. 252.82(f)(2).
\244\ See final rule Sec. 252.82(c)(2).
---------------------------------------------------------------------------
Certain commenters opposed application of the requirements of the
rule to existing QFCs, requesting instead that the final rule only
apply to QFCs entered into after the effective date of any final rule
and that all pre-existing QFCs not be subject to the rule's
requirements. Commenters suggested that end users of QFCs with GSIB
affiliates might not have entered into existing contracts without the
default rights prohibited in the proposed rule and that revising
existing QFCs would be time-consuming and expensive. Commenters pointed
out that this treatment would be consistent with the final rules in the
United Kingdom and the statutory requirements adopted by Germany.
The Board does not believe it is appropriate to exclude all pre-
existing QFCs because of the current and future risk that existing
covered QFCs pose to the orderly resolution of a covered entity.
Moreover, application of different default rights to existing and
future transactions within a netting set could cause the netting set to
be broken, which commenters noted could increase burden to both parties
to the netting set.\245\ Therefore, the final rule requires an existing
QFC between a covered entity and a counterparty to be conformed to the
requirements of the final rule if the covered entity (or an affiliate
that is a covered entity or excluded bank) enters into another QFC with
the counterparty or its consolidated affiliate on or after the first
day of the calendar quarter immediately following one year from the
effective date of the final rule.\246\ By permitting a covered entity
to remain a party to noncompliant QFCs entered before the effective
date unless the covered entity or any affiliate (that is also a covered
entity or excluded bank) enters into new QFCs with the same
counterparty or its affiliates, the final rule strikes a balance
between ensuring QFC continuity if the GSIB were to fail and ensuring
that covered entities and their existing counterparties can manage any
compliance costs and disruptions associated with conforming existing
QFCs by refraining from entering into new QFCs. The requirement that a
covered entity ensure that all existing QFCs with a particular
counterparty and its affiliates are compliant before it or any
affiliate of the covered entity (that is also a covered entity or
excluded bank) enters into a new QFC with the same counterparty or its
affiliates after the effective date will provide covered entities with
an incentive to seek the modifications necessary to ensure that their
QFCs with their most important counterparties are compliant. Moreover,
the volume of noncompliant covered
[[Page 42914]]
QFCs outstanding can be expected to decrease over time and eventually
to reach zero. In light of these considerations, and to avoid creating
potentially inappropriate compliance costs with respect to existing
QFCs with counterparties that, together with their consolidated
affiliates, do not enter into new covered QFCs with the GSIB on or
after the first day of the calendar quarter that is one year from the
effective date of the final rule, it would be appropriate to permit a
limited number of noncompliant QFCs to remain outstanding, in keeping
with the terms described above. Moreover, the final rule also excludes
existing warrants and retail investment advisory agreements to address
concerns raised by commenters and mitigate burden.\247\ That said, the
Board will monitor covered entities' levels of noncompliant QFCs and
evaluate the risk, if any, that they pose to the safety and soundness
of the GSIBs or to U.S. financial stability.
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\245\ The requirements of the final rule, particularly those of
section 252.84, may have a different impact on netting, including
close-out netting, than the U.K. and German requirements cited by
commenters.
\246\ Subject to any compliance date applicable to the covered
entity, the Board expects a covered entity to conform existing QFCs
that become covered QFCs within a reasonable period.
\247\ See final rule Sec. 252.88(c).
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IV. Costs and Benefits
The Board invited comment on its evaluation of the costs and
benefits of the proposal. In response to comments received, the Board
has made a number of changes to the proposal that are expected to
reduce costs and burdens of compliance with the final rule while at the
same time ensuring that the final rule serves its intended purposes.
A number of commenters argued that particular aspects of the
proposal were burdensome and costly as described throughout this
SUPPLEMENTARY INFORMATION. One commenter stated that the proposal was
overly complex and difficult for market participants to evaluate and
for courts to interpret, which could lead to potentially different or
conflicting interpretations.\248\ Another commenter contended that the
Board has not adequately considered the litigation costs that will
result from the final rule's heightened burden of proof. Certain
commenters expressed the view that the proposal made unquantified
assumptions about the costs, provided no evidence that benefits would
outweigh the costs, and did not discuss the impact of the requirements
for particular market segments (e.g., physical commodity markets).
Certain commenters urged the Board to consider the costs of the
contractual default rights lost under the rule and to consider the
compliance costs and additional collateral costs the rule will impose
on non-GSIB parties to QFCs (including parties not regulated by the
Board), particularly in stress scenarios where the non-GSIB party
cannot require the GSIB counterparty to post collateral. Some
commenters contended that GSIB entities will have to compensate
sophisticated non-covered entities for the additional risks they are
forced to incur if forced to give up default rights and will bear the
cost of the economic barriers to engaging in international finance that
follow from this rule. A few commenters argued that, before the Board
proceeds to finalize this rule, the Board should conduct a study and
assessment of the costs and benefit as well as the market impact of the
proposed rules, the TLAC rules, and the broader FSB initiatives, with a
specific focus on application to existing default rights and the impact
on all affected market participants.
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\248\ Some commenters requested that the rule be rewritten to be
more understandable to non-covered entity counterparties and that
the Board release FAQs regarding this final rule that are
understandable to non-financial counterparties. The Board has
endeavored to clarify the final rule as much as possible and has
discussed those clarifications throughout this SUPPLEMENTARY
INFORMATION. The Board does not believe FAQs for this final rule are
required at this time, but will consider the need for such FAQs in
the future.
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Other commenters pointed out that since large banks already adhere
to the Universal Protocol, more than 90 percent of outstanding notional
swaps are already subject to stays. These commenters argued that
further study and analysis was needed to determine whether it is
necessary to restrict end-user default rights by subjecting them
indirectly to the proposed rule to capture the remaining 10 percent of
the swaps market, including why the benefits outweigh the costs.
Commenters also urged further analysis of why other categories of QFCs
present the same concerns as swaps such that it is necessary for the
Board to alter default rights contained therein (e.g., commodity and
forward contracts) and the likely effect of the proposed rule on the
markets for such QFCs.
One commenter argued that the benefits of the proposal likely
substantially outweigh the costs. This commenter contended that the
losses in the Lehman bankruptcy alone due to the ability of
counterparties to close out QFCs and seize collateral destroyed
millions if not billions of dollars and argued that the exemption of
QFCs from the automatic stay of the U.S. Bankruptcy Code has
effectively subsidized the cost of credit extended among QFC
participants. In this commenter's view, any increase in the cost of
QFCs relative to other financial instruments does not reflect true
additional cost but rather reflects the loss of this implicit subsidy.
The commenter estimated that the 2008 financial crisis following the
Lehman bankruptcy had an estimated cost in lost or avoided gross
domestic product of more than $20 trillion.
The final rule is intended to yield substantial net benefits for
the financial stability of the United States by reducing the potential
that resolution of a GSIB, particularly a resolution in bankruptcy,
will be disorderly and disruptive to financial stability. These
benefits are expected to substantially outweigh the costs associated
with the final rule.
The costs of the final rule to covered entities and their QFC
counterparties would generally be of three types. The first cost would
be the cost to QFC counterparties arising from the relinquishment of
certain rights, such as cross-default rights, that would have been
permitted prior to the rule. However, the costs of restricting such
rights are expected to be low as the nature of the rights that are
restricted is narrow, the likelihood of exercising such rights is low,
and other forms of protection are available that are not prohibited by
the rule.
The second cost associated with the rule is the cost of lost
revenue for covered entities that might result if non-covered entity
counterparties refuse to engage in QFCs with covered entities as a
result of the reduction in rights required by the rule. This cost,
however, only accrues in the aggregate to the financial system to the
extent that non-covered entity counterparties refuse to engage in QFCs
with any counterparty. Third and finally, this rule imposes costs on
covered entities and non-covered entities to the extent that they are
required to bear legal and administrative costs associated with
drafting and negotiating compliant contracts. These costs are expected
to be small relative to the costs of doing business in the financial
sector generally. Moreover, the final rule explicitly allows for the
use of standardized industry protocols in lieu of complying with the
terms of the rule, which should reduce the legal and administrative
costs associated with complying with the rule.
The Board has taken into account the information regarding costs
and benefits provided by commenters and modified the proposed rule to
reduce costs. To reduce the overall burden, the final rule contains a
number of changes to respond to commenter concerns. As described above,
the final rule reduces compliance and negotiating costs by excluding
contracts from the scope of ``covered QFCs'' subject to the
requirements of the final rule to the extent the contract contains no
default, cross-default, or transfer restrictions.
[[Page 42915]]
Commenters argued that remediating such contracts would be costly
without an attendant benefit to resolution of a GSIB. The final rule
also only requires remediation of existing contracts with a
counterparty if the counterparty or a consolidated affiliate of the
counterparty enters into a new QFC with the covered entity (or certain
affiliates). This change to consolidated affiliate is in response to
many commenters' argument that burden would be mitigated by defining
counterparties by reference to financial consolidation. Additionally,
in certain cases, where remediation of existing contracts would be
difficult, the Board excludes such existing contracts from the scope of
coverage of the requirements of the final rule. Finally, the final rule
allows for the application of two standardized industry protocols as a
means of complying with the requirements of the final rule. Adhering to
an industry protocol will provide for a low cost and efficient means of
compliance that does not result in excessive amounts of legal or
administrative costs.
The final rule similarly excludes from section 252.83 contracts
that are with U.S. counterparties and governed by U.S. law. Commenters
argued that renegotiating these contracts would be burdensome with no
benefit to resolution. The final rule has also been modified to address
concerns raised by foreign GSIBs regarding QFCs under multi-branch
master agreements by excluding from the rule QFCs where only payment or
delivery may be made at a U.S. branch or agency. Foreign GSIB
commenters urged that this change would eliminate the need under the
proposal to modify thousands of contracts at great cost.
The final rule also provides a longer transition period requested
by commenters for certain counterparties in order to help mitigate the
compliance burden on covered entities and their counterparties.
The Board believes that the changes above address many of the
significant concerns raised by commenters regarding the burdens of the
proposed rule and should serve to mitigate the compliance costs of the
final rule. The Board also notes that application of the final rule is
limited to GSIBs and believes that this approach to limiting the
application of this final rule sensibly balances the costs and benefits
of the rule by effectively managing systemic risk while at the same
time limiting the burden of compliance by not requiring non-GSIB firms
to comply with any part of this final rule.
Additionally, the stay-and-transfer provisions of the Dodd-Frank
Act and the FDI Act are already in force, and the Universal Protocol is
already partially effective. This observation provides further support
for the view that any marginal costs created by the final rule--which
is intended to extend the effects of the stay-and-transfer provisions
under those acts and the Universal Protocol--are unlikely to be
material.
Thus, the costs of the final rule are likely to be small relative
to its benefits. These relatively small costs appear to be
significantly outweighed by the substantial benefits that the rule
would produce for the U.S. economy. Financial crises impose enormous
costs on the real economy, so even small reductions in the probability
or severity of future financial crises create substantial economic
benefits. The final rule would materially reduce the risk to the
financial stability of the United States that could arise from the
severe distress or failure of a GSIB by enhancing the prospects for the
orderly resolution of such a firm and would thereby materially reduce
the probability and severity of financial crises in the future. The
final rule would therefore advance a key objective of the Dodd-Frank
Act and help protect the American economy from the substantial costs
associated with more frequent and severe financial crises.
In addition, the final rule would likely benefit subsidiaries of a
failed GSIB, as well as their counterparties and creditors, by helping
to prevent the disorderly failure of the subsidiaries and allowing them
to continue to meet their obligations. Moreover, non-covered entity
counterparties may choose to engage in QFCs with non-GSIB
counterparties, in which case revenue that is lost by a GSIB may be
recouped by a non-GSIB and aggregate QFC activity by the financial
system would not decline.
V. Revisions to Certain Definitions in the Board's Capital and
Liquidity Rules
The final rule also amends several definitions in the Board's
capital and liquidity rules to help ensure that the final rule would
not have unintended effects for the treatment of covered entities'
netting sets under those rules. The amendments are similar to the
proposed rule as well as revisions that the Board and the OCC made in a
2014 interim final rule to prevent similar effects from foreign
jurisdictions' special resolution regimes and firms' adherence to the
2014 Universal Protocol.\249\
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\249\ See 12 CFR part 217.
---------------------------------------------------------------------------
The Board's regulatory capital rules permit a banking organization
to measure exposure from certain types of financial contracts on a net
basis and recognize the risk-mitigating effect of financial collateral
for other types of exposures, provided that the contracts are subject
to a ``qualifying master netting agreement'' or agreement that provides
for certain rights upon the default of a counterparty.\250\ The Board
has defined ``qualifying master netting agreement'' to mean a netting
agreement that permits a banking organization to terminate, apply
close-out netting, and promptly liquidate or set off collateral upon an
event of default of the counterparty, thereby reducing its counterparty
exposure and market risks.\251\ On the whole, measuring the amount of
exposure of these contracts on a net basis, rather than on a gross
basis, results in a lower measure of exposure and thus a lower capital
requirement.
---------------------------------------------------------------------------
\250\ See id.
\251\ See 12 CFR 217.2.
---------------------------------------------------------------------------
The current definition of ``qualifying master netting agreement''
recognizes that default rights may be stayed if the financial company
is in resolution under the Dodd-Frank Act, the FDI Act, a substantially
similar law applicable to government-sponsored enterprises, or a
substantially similar foreign law, or where the agreement is subject by
its terms to any of those laws. Accordingly, transactions conducted
under netting agreements where default rights may be stayed in those
circumstances may qualify for the favorable capital treatment described
above. However, the current definition of ``qualifying master netting
agreement'' does not recognize the restrictions that the final rule
would impose on the QFCs of covered entities. Thus, a master netting
agreement that is compliant with the final rule would not qualify as a
qualifying master netting agreement. This would result in considerably
higher capital and liquidity requirements for QFC counterparties of
covered entities, which is not an intended effect of the final rule.
Accordingly, the final rule amends the definition of ``qualifying
master netting agreement'' so that a master netting agreement could
qualify for such treatment where the right to accelerate, terminate,
and close-out on a net basis all transactions under the agreement and
to liquidate or set off collateral promptly upon an event of default of
the counterparty is consistent with the
[[Page 42916]]
requirements of the final rule. This revision maintains the existing
treatment for these contracts under the Board's capital and liquidity
rules by accounting for the restrictions that the final rule, or the
substantively identical rules expected to be issued by the FDIC and
OCC, would place on default rights related to covered entities' and
excluded banks' QFCs. The Board does not believe that the
disqualification of master netting agreements that would result in the
absence of the amendment would accurately reflect the risk posed by the
affected QFCs. As discussed above, the implementation of consistent
restrictions on default rights in GSIB QFCs would increase the
prospects for the orderly resolution of a failed GSIB and thereby
protect the financial stability of the United States.
The final rule similarly revises certain other definitions in the
regulatory capital rules to make analogous conforming changes designed
to account for the final rule's restrictions and ensure that a banking
organization may continue to recognize the risk-mitigating effects of
financial collateral received in a secured lending transaction, repo-
style transaction, or eligible margin loan for purposes of the Board's
rules. Specifically, the final rule revises the definitions of
``collateral agreement,'' ``eligible margin loan,'' and ``repo-style
transaction'' to provide that a counterparty's default rights may be
limited as required by the final rule without unintended effects.\252\
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\252\ As noted above, the FDIC and OCC are expected to issue
substantively identical final rules in the near future. A Board-
regulated instiution that amends a qualifying master netting
agreement, collateral agreement, eligible margin loan, or repo-style
transaction to the extent necessary for its counterparty to conform
the agreement to any final rules issued by the FDIC or OCC would
continue to meet such definition under the Board's capital and/or
liquidity rules, regardless of whether the agreement is amended
before the effective date of any final rule issued by the FDIC or
OCC.
---------------------------------------------------------------------------
The rule establishing margin and capital requirements for covered
swap entities (swap margin rule) defines the term ``eligible master
netting agreement'' in a manner similar to the definition of
``qualifying master netting agreement.'' \253\ Thus, it may also be
appropriate to amend the definition of ``eligible master netting
agreement'' to account for the restrictions on covered entities' QFCs.
Because the Board issued the swap margin rule jointly with other U.S.
regulatory agencies, however, the Board is consulting with the other
prudential regulators regarding amending that rule's definition of
``eligible master netting agreement.''
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\253\ 80 FR 74840, 74861-62 (Nov. 30, 2015).
---------------------------------------------------------------------------
Certain commenters requested technical modifications to the
proposed modifications to the definitions to better distinguish the
requirements of section 252.84 and the provisions of Section 2 of the
Universal Protocol from provisions regarding ``opt in'' to special
resolution regimes. In response to this comment, the final rule
establishes an independent exception addressing the requirements of
section 252.84 and the provisions of Section 2 of the Universal
Protocol and makes other minor clarifying edits.
One commenter requested that the definitions of the terms
``collateral agreement,'' ``eligible margin loan,'' ``qualifying master
netting agreement,'' and ``repo-style transaction'' include references
to stays in state resolution regimes (such as insurance receiverships).
The commenters did not identify, and the Board is not aware of, any
state resolution regime that currently includes QFC stays similar to
those of the U.S. Special Resolution Regimes. Neither the nature of the
potential laws nor the extent of their effect on the regulatory capital
requirements of Board-regulated institutions is known. Therefore, the
final rule does not reference state resolution regimes.
One commenter argued that neither the current nor the proposed
definition of qualifying master netting agreement comports with section
302(a) of the Business Risk Mitigation and Price Stabilization Act of
2015, which exempts certain types of counterparties from initial and
variation margin requirements, and that the proposed amendments to the
definition add unnecessary complexity to the Board's existing rules and
therefore make compliance more difficult. Section 302(a) of that act is
not relevant to the definition of qualifying master netting agreement
because the definition does not require initial or variation margin.
Rather, the definition of qualifying master netting agreement requires
that margin provided under the agreement, if any, be able to be
promptly liquidated or set off under the circumstances specified in the
definition. The Board continues to believe that the amendments are
necessary and do not substantially add to the complexity of the Board's
rules.
VI. Regulatory Analysis
A. Paperwork Reduction Act
Certain provisions of the final rule contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act (PRA) of 1995 (44 U.S.C. 3501 through 3521). The Board
reviewed the final rule under the authority delegated to the Board by
the Office of Management and Budget (OMB). The reporting requirements
are found in sections 252.85(b) and 252.87(b) of the final rule. These
information collection requirements would be implemented pursuant to
section 165 of the Dodd-Frank Act, as well as its safety and soundness
and other relevant authorities, as described in the Abstract below. In
accordance with the requirements of the PRA, the Board may not conduct
or sponsor, and the respondent is not required to respond to, an
information collection unless it displays a currently valid OMB control
number.
The final rule would revise the Reporting, Recordkeeping, and
Disclosure Requirements Associated with Enhanced Prudential Standards
(Regulation YY) (Reg YY; OMB No. 7100-0350). In addition, as permitted
by the PRA, the Board proposes to extend for three years, with
revision, the Reporting, Recordkeeping, and Disclosure Requirements
Associated with Enhanced Prudential Standards (Regulation YY) (Reg YY;
OMB No. 7100-0350). The Board received no comments on the PRA.
The Board has a continuing interest in the public's opinions of
collections of information. At any time, commenters may submit comments
regarding the burden estimate, or any other aspect of this collection
of information, including suggestions for reducing the burden, to the
ADDRESSES section. All comments will become a matter of public record.
Additionally, commenters may send a copy of their comments to the OMB
desk officer for the agency by mail to the Office of Information and
Regulatory Affairs, U.S. Office of Management and Budget, New Executive
Office Building, Room 10235, 725 17th Street NW., Washington, DC 20503;
by fax to (202) 395-6974; or by email to [email protected].
Proposed Revision, With Extension, of the Following Information
Collection
Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Enhanced Prudential Standards
(Regulation YY).
Agency Form Number: Reg YY.
OMB Control Number: 7100-0350.
Frequency of Response: Annual, semiannual, quarterly, one-time, and
on occasion.
Affected Public: Businesses or other for-profit.
Respondents: State member banks, U.S. bank holding companies,
savings and loan holding companies, nonbank
[[Page 42917]]
financial companies, foreign banking organizations, U.S. intermediate
holding companies, foreign savings and loan holding companies, and
foreign nonbank financial companies supervised by the Board.
Abstract: Section 165 of the Dodd-Frank Act requires the Board to
implement enhanced prudential standards for bank holding companies with
total consolidated assets of $50 billion or more, including global
systemically important foreign banking organizations with $50 billion
or more in total consolidated assets. Section 165 of the Dodd-Frank Act
also permits the Board to establish such other prudential standards for
such banking organizations as the Board determines are appropriate.
This regulation is being implemented by the Board under section 165 of
the Dodd-Frank Act, as well as its safety and soundness and other
relevant authorities.\254\
---------------------------------------------------------------------------
\254\ 12 U.S.C. 321-338a, 481-486, 1467a, 1818, 1828, 1831n,
1831o, 1831p-l, 1831w, 1835, 1844(b), 1844(c), 3101 et seq., 3101
note, 3904, 3906-3909, 4808, 5361, 5362, 5365, 5366, 5367, 5368,
5371.
---------------------------------------------------------------------------
Reporting Requirements
Section 252.85(b) of the final rule would require a covered entity
to request the Board to approve as compliant with the requirements of
sections 252.83 and 252.84 of this subpart provisions of one or more
forms of covered QFCs, or proposed amendments to one or more forms of
covered QFCs, with enhanced creditor protection conditions. Enhanced
creditor protection conditions means a set of limited exemptions to the
requirements of section 252.84(b) of this subpart that are different
than those of paragraphs (d), (f), and (h) of section 252.84 of this
subpart. A covered entity making a request must provide (1) an analysis
of the proposal under each consideration of paragraph 252.85(d) of this
subpart; (2) a written legal opinion verifying that proposed provisions
or amendments would be valid and enforceable under applicable law of
the relevant jurisdictions, including, in the case of proposed
amendments, the validity and enforceability of the proposal to amend
the covered QFCs; and (3) any additional relevant information that the
Board requests.
Section 252.87(b) of the final rule would require each top-tier
foreign banking organization that determines that it has the
characteristics of a global systemically important banking organization
under the global methodology to notify the Board of the determination
by January 1 of each calendar year.\255\
---------------------------------------------------------------------------
\255\ Global methodology means the assessment methodology and
the higher loss absorbency requirement for global systemically
important banks issued by the Basel Committee on Banking
Supervision, as updated from time to time. 12 CFR 252.2(o).
---------------------------------------------------------------------------
Estimated Paperwork Burden for Proposed Revisions
Estimated Number of Respondents:
Section 252.85(b)--10 respondents.
Section 252.87(b)--22 respondents.
Estimated Burden per Response:
Section 252.85(b)--40 hours.
Section 252.87(b)--1 hour.
Current estimated annual burden for Reporting, Recordkeeping, and
Disclosure Requirements Associated with Enhanced Prudential Standards
(Regulation YY): 118,842 hours.
Proposed revisions estimated annual burden: 422 hours.
Total estimated annual burden: 119,264 hours.
B. Regulatory Flexibility Act: Final Regulatory Flexibility Analysis
The Regulatory Flexibility Act, 5 U.S.C. 601 et seq. (RFA),
generally requires that an agency prepare and make available an initial
regulatory flexibility analysis in connection with a notice of proposed
rulemaking.
The Board solicited public comment on this rule in a notice of
proposed rulemaking \256\ and has considered the potential impact of
this rule on small entities in accordance with section 604 of the RFA.
Based on the Board's analysis, and for the reasons stated below, the
Board believes the final rule will not have a significant economic
impact on a substantial number of small entities.
---------------------------------------------------------------------------
\256\ See 81 FR 29169 (May 11, 2016).
---------------------------------------------------------------------------
Under regulations issued by the Small Business Administration, a
small entity includes a depository institution, bank holding company,
or savings and loan holding company with assets of $550 million or less
(small banking entities).\257\ Based on data as of June 2017, there are
approximately 3,758 bank holding companies, savings and loan holding
companies, and state member banks that have total domestic assets of
$550 million or less and thus are considered small entities for
purposes of the RFA. Based on the Board's analysis, and for the reasons
stated below, the Board believes the final rule will not have a
significant economic impact on a substantial number of small entities.
---------------------------------------------------------------------------
\257\ See 13 CFR 121.201. Effective July 14, 2014, the Small
Business Administration revised the size standards for banking
organizations to $550 million in assets from $500 million in assets.
79 FR 33647 (June 12, 2014).
---------------------------------------------------------------------------
1. Statement of the need for, and objectives of, the final rule.
As discussed, the Board is issuing this final rule as part of its
program to make GSIBs more resolvable in order to reduce the risk that
their failure would pose to the financial stability of the United
States, consistent with section 165 of the Dodd-Frank Act. In
particular, the primary purpose of the final rule is to reduce the risk
that the exercise of default rights by a failing GSIB's QFC
counterparties would lead to a disorderly failure of the GSIB and would
produce negative contagion and disruption that could destabilize the
U.S. financial system.
2. Significant issues raised by the public comments in response to
the IRFA and comments filed by the Chief Counsel for Advocacy of the
Small Business Administration in response to the proposed rule and
summary of any changes made in the proposed rule as a result of such
comments.
Commenters did not raise any issues in response to the IRFA. The
Chief Counsel for Advocacy of the Small Business Administration did not
file any comments in response to the proposed rule.
3. Description and estimate of the number of small entities to
which the final rule will apply.
The final rule's requirements to conform covered QFCs would only
apply to GSIBs, which are the largest, most systemically important
banking organizations, and certain of their subsidiaries. More
specifically, the final rule would apply to (a) any U.S. GSIB top-tier
bank holding company, (b) any subsidiary of such a bank holding company
other than the exceptions described in the SUPPLEMENTARY INFORMATION
above for institutions regulated by the FDIC and OCC and certain
investments, and (c) the U.S. operations of any foreign GSIB other than
the exceptions described in the SUPPLEMENTARY INFORMATION above for
institutions regulated by the FDIC and OCC and certain investments. The
Board estimates that these requirements would apply to approximately 30
banking organizations: Eight U.S. bank holding companies (i.e., U.S.
GSIBs) and approximately 22 foreign banking organizations (i.e.,
foreign GSIBs with U.S. operations). None of these banking
organizations would qualify as a small banking entity for the purposes
of the RFA. However, as discussed above, the final rule also applies to
each covered GSIB's subsidiary that meets the definition of a covered
entity (regardless of the subsidiary's size) because an
[[Page 42918]]
exemption for small entities would significantly impair the
effectiveness of the proposed stay-and-transfer provisions and thereby
undermine a key objective of the final rule: To reduce the execution
risk of an orderly GSIB resolution. The Board anticipates that any
small subsidiary of a GSIB that is covered by this final rule would
rely on its parent GSIB or a large subsidiary of that GSIB for
reporting, recordkeeping, or similar compliance requirements and would
not bear additional costs.
Section 252.87(b) of the final rule would require each top-tier
foreign banking organization that determines that it has the
characteristics of a global systemically important banking organization
under the global methodology to notify the Board of the determination
by January 1 of each calendar year.\258\ All of these organizations by
definition have $50 billion or more in total consolidated assets. None
of these banking organizations would qualify as a small banking entity
for the purposes of the RFA.
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\258\ Global methodology means the assessment methodology and
the higher loss absorbency requirement for global systemically
important banks issued by the Basel Committee on Banking
Supervision, as updated from time to time. 12 CFR 252.2(o).
---------------------------------------------------------------------------
4. Significant alternatives to the final rule.
In light of the foregoing, the Board does not believe that this
final rule will have a significant negative economic impact on any
small entities and therefore believes that there are no significant
alternatives to the final rule that would reduce the impact on small
entities.
5. Steps taken to minimize the significant economic impact on small
entities.
As noted, the Board believes that an exemption for small entities
would significantly impair the effectiveness of the proposed stay-and-
transfer provisions and thereby undermine a key objective of the final
rule: To reduce the execution risk of an orderly GSIB resolution. The
Board did not receive any comments from small entities suggesting
alternatives specific to those entities or quantifying their projected
costs. The Board received, however, general comments that suggested
alternatives that would reduce the burden on entities without regard to
size. The Board has considered those comments and changes in the final
rule in response to such comments in other sections of this
SUPPLEMENTARY INFORMATION section. In addition, the Board anticipates
that any small subsidiary of a GSIB that is covered by this final rule
would rely on its parent GSIB or a large subsidiary of that GSIB for
reporting, recordkeeping, or similar compliance requirements and would
not bear additional costs.
C. Riegle Community Development and Regulatory Improvement Act of 1994
The Riegle Community Development and Regulatory Improvement Act of
1994 (RCDRIA) requires that each Federal banking agency, in determining
the effective date and administrative compliance requirements for new
regulations that impose additional reporting, disclosure, or other
requirements on insured depository institutions, consider, consistent
with principles of safety and soundness and the public interest, any
administrative burdens that such regulations would place on depository
institutions, including small depository institutions, and customers of
depository institutions, as well as the benefits of such regulations.
The Board has considered comment on these matters in other sections of
this SUPPLEMENTARY INFORMATION section.
In addition, new regulations that impose additional reporting,
disclosures, or other new requirements on insured depository
institutions generally must take effect on the first day of a calendar
quarter that begins on or after the date on which the regulations are
published in final form. Therefore, covered entities, which include
certain insured depository institutions, are required to comply with
the requirements of the final rule on the first day of calendar
quarters after the effective date of the regulation.
D. Use of Plain Language
Section 722 of the Gramm-Leach-Bliley Act requires the U.S. banking
agencies to use plain language in all proposed and final rulemakings
published after January 1, 2000.\259\ The Board received no comment on
these matters and believes that the final rule is written plainly and
clearly.
---------------------------------------------------------------------------
\259\ 12 U.S.C. 4809(a).
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List of Subjects in 12 CFR Parts 217, 249, and 252
Administrative practice and procedure, Banks, Banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
Authority and Issuance
For the reasons stated in the Supplementary Information, the Board
of Governors of the Federal Reserve System amends 12 CFR parts 217,
249, and 252 as follows:
PART 217--CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND
LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q)
0
1. The authority citation for part 217 continues to read as follows:
Authority: 12 U.S.C. 248(a), 321-338a, 481-486, 1462a, 1467a,
1818, 1828, 1831n, 1831o, 1831p-l, 1831w, 1835, 1844(b), 1851, 3904,
3906-3909, 4808, 5365, 5368, 5371.
0
2. Section 217.2 is amended by:
0
a. Revising the definition of ``collateral agreement'';
0
b. Revising paragraph (1)(iii) of the definition of ``eligible margin
loan'';
0
c. Revising the definition of ``qualifying master netting agreement'';
0
d. Republishing the introductory text of the definition of ``repo-style
transaction''; and
0
e. Revising paragraph (3)(ii)(A) of the definition of ``repo-style
transaction''.
The revisions and republication are set forth below:
Sec. 217.2 Definitions.
* * * * *
Collateral agreement means a legal contract that specifies the time
when, and circumstances under which, a counterparty is required to
pledge collateral to a Board-regulated institution for a single
financial contract or for all financial contracts in a netting set and
confers upon the Board-regulated institution a perfected, first-
priority security interest (notwithstanding the prior security interest
of any custodial agent), or the legal equivalent thereof, in the
collateral posted by the counterparty under the agreement. This
security interest must provide the Board-regulated institution with a
right to close-out the financial positions and liquidate the collateral
upon an event of default of, or failure to perform by, the counterparty
under the collateral agreement. A contract would not satisfy this
requirement if the Board-regulated institution's exercise of rights
under the agreement may be stayed or avoided:
(1) Under applicable law in the relevant jurisdictions, other than:
(i) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs, or laws of foreign
jurisdictions that are substantially similar \4\ to the U.S. laws
[[Page 42919]]
referenced in this paragraph (1)(i) in order to facilitate the orderly
resolution of the defaulting counterparty;
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\4\ The Board expects to evaluate jointly with the OCC and
Federal Deposit Insurance Corporation whether foreign special
resolution regimes meet the requirements of this paragraph.
---------------------------------------------------------------------------
(ii) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (1)(i) of this
definition; or
(2) Other than to the extent necessary for the counterparty to
comply with the requirements of subpart I of the Board's Regulation YY
(part 252 of this chapter), part 47 of this title, or part 382 of this
title, as applicable.
* * * * *
Eligible margin loan means:
(1) * * *
(iii) The extension of credit is conducted under an agreement that
provides the Board-regulated institution the right to accelerate and
terminate the extension of credit and to liquidate or set-off
collateral promptly upon an event of default, including upon an event
of receivership, insolvency, liquidation, conservatorship, or similar
proceeding, of the counterparty, provided that, in any such case:
(A) Any exercise of rights under the agreement will not be stayed
or avoided under applicable law in the relevant jurisdictions, other
than:
(1) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs,\5\ or laws of foreign
jurisdictions that are substantially similar \6\ to the U.S. laws
referenced in this paragraph (1)(iii)(A)(1) in order to facilitate the
orderly resolution of the defaulting counterparty; or
---------------------------------------------------------------------------
\5\ This requirement is met where all transactions under the
agreement are (i) executed under U.S. law and (ii) constitute
``securities contracts'' under section 555 of the Bankruptcy Code
(11 U.S.C. 555), qualified financial contracts under section
11(e)(8) of the Federal Deposit Insurance Act, or netting contracts
between or among financial institutions under sections 401-407 of
the Federal Deposit Insurance Corporation Improvement Act or the
Federal Reserve Board's Regulation EE (12 CFR part 231).
\6\ The Board expects to evaluate jointly with the OCC and
Federal Deposit Insurance Corporation whether foreign special
resolution regimes meet the requirements of this paragraph.
---------------------------------------------------------------------------
(2) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (1)(iii)(A)(1) of
this definition; and
(B) The agreement may limit the right to accelerate, terminate, and
close-out on a net basis all transactions under the agreement and to
liquidate or set-off collateral promptly upon an event of default of
the counterparty to the extent necessary for the counterparty to comply
with the requirements of subpart I of the Board's Regulation YY (part
252 of this chapter), part 47 of this title, or part 382 of this title,
as applicable.
* * * * *
Qualifying master netting agreement means a written, legally
enforceable agreement provided that:
(1) The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default following any stay permitted by paragraph (2) of this
definition, including upon an event of receivership, conservatorship,
insolvency, liquidation, or similar proceeding, of the counterparty;
(2) The agreement provides the Board-regulated institution the
right to accelerate, terminate, and close-out on a net basis all
transactions under the agreement and to liquidate or set-off collateral
promptly upon an event of default, including upon an event of
receivership, conservatorship, insolvency, liquidation, or similar
proceeding, of the counterparty, provided that, in any such case:
(i) Any exercise of rights under the agreement will not be stayed
or avoided under applicable law in the relevant jurisdictions, other
than:
(A) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs, or laws of foreign
jurisdictions that are substantially similar \7\ to the U.S. laws
referenced in this paragraph (2)(i)(A) in order to facilitate the
orderly resolution of the defaulting counterparty; or
---------------------------------------------------------------------------
\7\ The Board expects to evaluate jointly with the OCC and
Federal Deposit Insurance Corporation whether foreign special
resolution regimes meet the requirements of this paragraph.
---------------------------------------------------------------------------
(B) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (2)(i)(A) of this
definition; and
(ii) The agreement may limit the right to accelerate, terminate,
and close-out on a net basis all transactions under the agreement and
to liquidate or set-off collateral promptly upon an event of default of
the counterparty to the extent necessary for the counterparty to comply
with the requirements of subpart I of the Board's Regulation YY (part
252 of this chapter), part 47 of this title, or part 382 of this title,
as applicable;
* * * * *
Repo-style transaction means a repurchase or reverse repurchase
transaction, or a securities borrowing or securities lending
transaction, including a transaction in which the Board-regulated
institution acts as agent for a customer and indemnifies the customer
against loss, provided that:
(3) * * *
(ii) * * *
(A) The transaction is executed under an agreement that provides
the Board-regulated institution the right to accelerate, terminate, and
close-out the transaction on a net basis and to liquidate or set-off
collateral promptly upon an event of default, including upon an event
of receivership, insolvency, liquidation, or similar proceeding, of the
counterparty, provided that, in any such case:
(1) Any exercise of rights under the agreement will not be stayed
or avoided under applicable law in the relevant jurisdictions, other
than:
(i) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs, or laws of foreign
jurisdictions that are substantially similar \8\ to the U.S. laws
referenced in this paragraph (3)(ii)(A)(1)(i) in order to facilitate
the orderly resolution of the defaulting counterparty;
---------------------------------------------------------------------------
\8\ The Board expects to evaluate jointly with the OCC and
Federal Deposit Insurance Corporation whether foreign special
resolution regimes meet the requirements of this paragraph.
---------------------------------------------------------------------------
(ii) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (3)(ii)(A)(1)(i)
of this definition; and
(2) The agreement may limit the right to accelerate, terminate, and
close-out on a net basis all transactions under the agreement and to
liquidate or set-off collateral promptly upon an event of default of
the counterparty to the extent necessary for the counterparty to comply
with the requirements of subpart I of the Board's Regulation YY (part
252 of this chapter), part 47 of this title, or part 382 of this title,
as applicable; or
* * * * *
PART 249--LIQUIDITY RISK MEASUREMENT STANDARDS (REGULATION WW)
0
3. The authority citation for part 249 continues to read as follows:
Authority: 12 U.S.C. 248(a), 321-338a, 481-486, 1467a(g)(1),
1818, 1828, 1831p-1, 1831o-1, 1844(b), 5365, 5366, 5368.
0
4. Section 249.3 is amended by revising the definition of ``qualifying
master netting agreement'' to read as follows:
Sec. 249.3 Definitions.
* * * * *
[[Page 42920]]
Qualifying master netting agreement means a written, legally
enforceable agreement provided that:
(1) The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default following any stay permitted by paragraph (2) of this
definition, including upon an event of receivership, conservatorship,
insolvency, liquidation, or similar proceeding, of the counterparty;
(2) The agreement provides the Board-regulated institution the
right to accelerate, terminate, and close-out on a net basis all
transactions under the agreement and to liquidate or set-off collateral
promptly upon an event of default, including upon an event of
receivership, conservatorship, insolvency, liquidation, or similar
proceeding, of the counterparty, provided that, in any such case:
(i) Any exercise of rights under the agreement will not be stayed
or avoided under applicable law in the relevant jurisdictions, other
than:
(A) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs, or laws of foreign
jurisdictions that are substantially similar \1\ to the U.S. laws
referenced in this paragraph (2)(i)(A) in order to facilitate the
orderly resolution of the defaulting counterparty;
---------------------------------------------------------------------------
\1\ The Board expects to evaluate jointly with the OCC and
Federal Deposit Insurance Corporation whether foreign special
resolution regimes meet the requirements of this paragraph.
---------------------------------------------------------------------------
(B) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (2)(i)(A) of this
definition; and
(ii) The agreement may limit the right to accelerate, terminate,
and close-out on a net basis all transactions under the agreement and
to liquidate or set-off collateral promptly upon an event of default of
the counterparty to the extent necessary for the counterparty to comply
with the requirements of subpart I of the Board's Regulation YY (part
252 of this chapter), part 47 of this title, or part 382 of this title,
as applicable;
* * * * *
PART 252--ENHANCED PRUDENTIAL STANDARDS (REGULATION YY)
0
5. The authority citation for part 252 continues to read as follows:
Authority: 12 U.S.C. 321-338a, 481-486, 1467a, 1818, 1828,
1831n, 1831o, 1831p-l, 1831w, 1835, 1844(b), 1844(c), 3101 et seq.,
3101 note, 3904, 3906-3909, 4808, 5361, 5362, 5365, 5366, 5367,
5368, 5371.
0
6. Add subpart I to read as follows:
Subpart I--Requirements for Qualified Financial Contracts of Global
Systemically Important Banking Organizations
Sec.
252.81 Definitions.
252.82 Applicability.
252.83 U.S. Special Resolution Regimes.
252.84 Insolvency proceedings.
252.85 Approval of enhanced creditor protection conditions.
252.86 Foreign bank multi-branch master agreements.
252.87 Identification of global systemically important foreign
banking organizations.
252.88 Exclusion of certain QFCs.
Subpart I--Requirements for Qualified Financial Contracts of Global
Systemically Important Banking Organizations
Sec. 252.81 Definitions.
For purposes of this subpart:
Central counterparty (CCP) has the same meaning as in Sec. 217.2
of the Board's Regulation Q (12 CFR 217.2).
Chapter 11 proceeding means a proceeding under Chapter 11 of Title
11, United States Code (11 U.S.C. 1101-74.).
Consolidated affiliate means an affiliate of another company that
(1) Either consolidates the other company, or is consolidated by
the other company, on financial statements prepared in accordance with
U.S. Generally Accepted Accounting Principles, the International
Financial Reporting Standards, or other similar standards;
(2) Is, along with the other company, consolidated with a third
company on a financial statement prepared in accordance with principles
or standards referenced in paragraph (1) of this definition; or
(3) For a company that is not subject to principles or standards
referenced in paragraph (1), if consolidation as described in paragraph
(1) or (2) of this definition would have occurred if such principles or
standards had applied.
Default right (1) Means, with respect to a QFC, any:
(i) Right of a party, whether contractual or otherwise (including,
without limitation, rights incorporated by reference to any other
contract, agreement, or document, and rights afforded by statute, civil
code, regulation, and common law), to liquidate, terminate, cancel,
rescind, or accelerate such agreement or transactions thereunder, set
off or net amounts owing in respect thereto (except rights related to
same-day payment netting), exercise remedies in respect of collateral
or other credit support or property related thereto (including the
purchase and sale of property), demand payment or delivery thereunder
or in respect thereof (other than a right or operation of a contractual
provision arising solely from a change in the value of collateral or
margin or a change in the amount of an economic exposure), suspend,
delay, or defer payment or performance thereunder, or modify the
obligations of a party thereunder, or any similar rights; and
(ii) Right or contractual provision that alters the amount of
collateral or margin that must be provided with respect to an exposure
thereunder, including by altering any initial amount, threshold amount,
variation margin, minimum transfer amount, the margin value of
collateral, or any similar amount, that entitles a party to demand the
return of any collateral or margin transferred by it to the other party
or a custodian or that modifies a transferee's right to reuse
collateral or margin (if such right previously existed), or any similar
rights, in each case, other than a right or operation of a contractual
provision arising solely from a change in the value of collateral or
margin or a change in the amount of an economic exposure;
(2) With respect to Sec. 252.84, does not include any right under
a contract that allows a party to terminate the contract on demand or
at its option at a specified time, or from time to time, without the
need to show cause.
Excluded bank:
(1) Means a national bank, a Federal savings association, a Federal
branch, a Federal agency, or an FSI that is exempted from the scope of
this subpart pursuant to paragraph (b)(2) or (b)(3) of Sec. 252.82;
(2) Does not include any entity described in paragraph (1) of this
definition that is owned pursuant to section 3(a)(A)(ii) of the Bank
Holding Company Act (12 U.S.C. 1842(a)(A)(ii)); is owned by a
depository institution in satisfaction of debt previously contracted in
good faith; is a portfolio concern, as defined under 13 CFR 107.50,
that is controlled by a small business investment company, as defined
in section 103(3) of the Small Business Investment Act of 1958 (15
U.S.C. 662); is owned pursuant to paragraph (11) of section 5136 of the
Revised Statutes of the United States (12 U.S.C. 24); or is a DPC
branch subsidiary.
FDI Act proceeding means a proceeding in which the Federal Deposit
Insurance Corporation is appointed as conservator or receiver under
section 11 of the Federal Deposit Insurance Act (12 U.S.C. 1821).
[[Page 42921]]
FDI Act stay period means, in connection with an FDI Act
proceeding, the period of time during which a party to a QFC with a
party that is subject to an FDI Act proceeding may not exercise any
right that the party that is not subject to an FDI Act proceeding has
to terminate, liquidate, or net such QFC, in accordance with section
11(e) of the Federal Deposit Insurance Act (12 U.S.C. 1821(e)) and any
implementing regulations.
Financial counterparty means a person that is:
(1)(i) A bank holding company or an affiliate thereof; a savings
and loan holding company as defined in section 10(n) of the Home
Owners' Loan Act (12 U.S.C. 1467a(n)); a U.S. intermediate holding
company that is established or designated for purposes of compliance
with this part; or a nonbank financial company supervised by the Board;
(ii) A depository institution as defined in section 3(c) of the
Federal Deposit Insurance Act (12 U.S.C. 1813(c)); an organization that
is organized under the laws of a foreign country and that engages
directly in the business of banking outside the United States; a
Federal credit union or State credit union as defined in section 2 of
the Federal Credit Union Act (12 U.S.C. 1752(1) & (6)); an institution
that functions solely in a trust or fiduciary capacity as described in
section 2(c)(2)(D) of the Bank Holding Company Act (12 U.S.C.
1841(c)(2)(D)); an industrial loan company, an industrial bank, or
other similar institution described in section 2(c)(2)(H) of the Bank
Holding Company Act (12 U.S.C. 1841(c)(2)(H));
(iii) An entity that is state-licensed or registered as:
(A) A credit or lending entity, including a finance company; money
lender; installment lender; consumer lender or lending company;
mortgage lender, broker, or bank; motor vehicle title pledge lender;
payday or deferred deposit lender; premium finance company; commercial
finance or lending company; or commercial mortgage company; except
entities registered or licensed solely on account of financing the
entity's direct sales of goods or services to customers;
(B) A money services business, including a check casher; money
transmitter; currency dealer or exchange; or money order or traveler's
check issuer;
(iv) A regulated entity as defined in section 1303(20) of the
Federal Housing Enterprises Financial Safety and Soundness Act of 1992,
as amended (12 U.S.C. 4502(20)) or any entity for which the Federal
Housing Finance Agency or its successor is the primary federal
regulator;
(v) Any institution chartered in accordance with the Farm Credit
Act of 1971, as amended, 12 U.S.C. 2002 et seq., that is regulated by
the Farm Credit Administration;
(vi) Any entity registered with the Commodity Futures Trading
Commission as a swap dealer or major swap participant pursuant to the
Commodity Exchange Act of 1936 (7 U.S.C. 1 et seq.), or an entity that
is registered with the U.S. Securities and Exchange Commission as a
security-based swap dealer or a major security-based swap participant
pursuant to the Securities Exchange Act of 1934 (15 U.S.C. 78a et
seq.);
(vii) A securities holding company, with the meaning specified in
section 618 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (12 U.S.C. 1850a); a broker or dealer as defined in
sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)(4)-(5)); an investment adviser as defined in section
202(a) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)); an
investment company registered with the U.S. Securities and Exchange
Commission under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et
seq.); or a company that has elected to be regulated as a business
development company pursuant to section 54(a) of the Investment Company
Act of 1940 (15 U.S.C. 80a-53(a));
(viii) A private fund as defined in section 202(a) of the
Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)); an entity that
would be an investment company under section 3 of the Investment
Company Act of 1940 (15 U.S.C. 80a-3) but for section 3(c)(5)(C); or an
entity that is deemed not to be an investment company under section 3
of the Investment Company Act of 1940 pursuant to Investment Company
Act Rule 3a-7 (17 CFR 270.3a-7) of the U.S. Securities and Exchange
Commission;
(ix) A commodity pool, a commodity pool operator, or a commodity
trading advisor as defined, respectively, in sections 1a(10), 1a(11),
and 1a(12) of the Commodity Exchange Act of 1936 (7 U.S.C. 1a(10),
1a(11), and 1a(12)); a floor broker, a floor trader, or introducing
broker as defined, respectively, in sections 1a(22), 1a(23) and 1a(31)
of the Commodity Exchange Act of 1936 (7 U.S.C. 1a(22), 1a(23), and
1a(31)); or a futures commission merchant as defined in section 1a(28)
of the Commodity Exchange Act of 1936 (7 U.S.C. 1a(28));
(x) An employee benefit plan as defined in paragraphs (3) and (32)
of section 3 of the Employee Retirement Income and Security Act of 1974
(29 U.S.C. 1002);
(xi) An entity that is organized as an insurance company, primarily
engaged in writing insurance or reinsuring risks underwritten by
insurance companies, or is subject to supervision as such by a State
insurance regulator or foreign insurance regulator; or
(xii) An entity that would be a financial counterparty described in
paragraphs (1)(i)-(xi) of this definition, if the entity were organized
under the laws of the United States or any state thereof.
(2) The term ``financial counterparty'' does not include any
counterparty that is:
(i) A sovereign entity;
(ii) A multilateral development bank; or
(iii) The Bank for International Settlements.
Financial market utility (FMU) means any person, regardless of the
jurisdiction in which the person is located or organized, that manages
or operates a multilateral system for the purpose of transferring,
clearing, or settling payments, securities, or other financial
transactions among financial institutions or between financial
institutions and the person, but does not include:
(1) Designated contract markets, registered futures associations,
swap data repositories, and swap execution facilities registered under
the Commodity Exchange Act (7 U.S.C. 1 et seq.), or national securities
exchanges, national securities associations, alternative trading
systems, security-based swap data repositories, and swap execution
facilities registered under the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.), solely by reason of their providing facilities for
comparison of data respecting the terms of settlement of securities or
futures transactions effected on such exchange or by means of any
electronic system operated or controlled by such entities, provided
that the exclusions in this clause apply only with respect to the
activities that require the entity to be so registered; or
(2) Any broker, dealer, transfer agent, or investment company, or
any futures commission merchant, introducing broker, commodity trading
advisor, or commodity pool operator, solely by reason of functions
performed by such institution as part of brokerage, dealing, transfer
agency, or investment company activities, or solely by reason of acting
on behalf of a FMU or a participant therein in connection with the
furnishing by the FMU of services to its
[[Page 42922]]
participants or the use of services of the FMU by its participants,
provided that services performed by such institution do not constitute
critical risk management or processing functions of the FMU.
FSI means a state savings association or state nonmember bank (as
the terms are defined in section 3 of the Federal Deposit Insurance
Act, 12 U.S.C. 1813).
Investment advisory contract means any contract or agreement
whereby a person agrees to act as investment adviser to or to manage
any investment or trading account of another person.
Master agreement means a QFC of the type set forth in sections
210(c)(8)(D)(ii)(XI), (iii)(IX), (iv)(IV), (v)(V), or (vi)(V) of Title
II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (12
U.S.C. 5390(c)(8)(D)(ii)(XI), (iii)(IX), (iv)(IV), (v)(V), or (vi)(V))
or a master agreement that the Federal Deposit Insurance Corporation
determines by regulation is a QFC pursuant to section 210(c)(8)(D)(i)
of Title II of the act (12 U.S.C. 5390(c)(8)(D)(i)).
Person has the same meaning as in 12 CFR 225.2.
Qualified financial contract (QFC) has the same meaning as in
section 210(c)(8)(D) of Title II of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (12 U.S.C. 5390(c)(8)(D)).
Retail customer or counterparty has the same meaning as in Sec.
249.3 of the Board's Regulation WW (12 CFR 249.3).
Small financial institution means a company that:
(1) Is organized as a bank, as defined in section 3(a) of the
Federal Deposit Insurance Act, the deposits of which are insured by the
Federal Deposit Insurance Corporation; a savings association, as
defined in section 3(b) of the Federal Deposit Insurance Act, the
deposits of which are insured by the Federal Deposit Insurance
Corporation; a farm credit system institution chartered under the Farm
Credit Act of 1971; or an insured Federal credit union or State-
chartered credit union under the Federal Credit Union Act; and
(2) Has total assets of $10,000,000,000 or less on the last day of
the company's most recent fiscal year.
U.S. special resolution regimes means the Federal Deposit Insurance
Act (12 U.S.C. 1811-1835a) and regulations promulgated thereunder and
Title II of the Dodd-Frank Wall Street Reform and Consumer Protection
Act (12 U.S.C. 5381-5394) and regulations promulgated thereunder.
Sec. 252.82 Applicability.
(a) General requirement. A covered entity must ensure that each
covered QFC conforms to the requirements of Sec. Sec. 252.83 and
252.84.
(b) Covered entities. For purposes of this subpart, a covered
entity is:
(1) A bank holding company that is identified as a global
systemically important BHC pursuant to 12 CFR 217.402;
(2) A subsidiary of a company identified in paragraph (b)(1) of
this section other than a subsidiary that is:
(i) A national bank, a Federal savings association, a Federal
branch, a Federal agency, an FSI;
(ii) A company owned pursuant to section 3(a)(A)(ii), 4(c)(2),
4(k)(4)(H), or 4(k)(4)(I) of the Bank Holding Company Act (12 U.S.C.
1842(a)(A)(ii), 1843(c)(2), 1843(k)(4)(H), 1843(k)(4)(I));
(iii) A company owned by a depository institution in satisfaction
of debt previously contracted in good faith;
(iv) A portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662); or
(v) A company the business of which is to make investments that are
designed primarily to promote the public welfare, of the type permitted
under paragraph (11) of section 5136 of the Revised Statutes of the
United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs)); or
(3) A U.S. subsidiary, U.S. branch, or U.S. agency of a global
systemically important foreign banking organization other than a U.S.
subsidiary, U.S. branch, or U.S. agency that is:
(i) A national bank, a Federal savings association, a Federal
branch, a Federal agency, an FSI;
(ii) A company owned pursuant to section 3(a)(A)(ii), 4(c)(2),
4(k)(4)(H), or 4(k)(4)(I) of the Bank Holding Company Act (12 U.S.C.
1842(a)(A)(ii), 1843(c)(2), 1843(k)(4)(H), 1843(k)(4)(I));
(iii) A company owned by a depository institution in satisfaction
of debt previously contracted in good faith;
(iv) A portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662);
(v) A company the business of which is to make investments that are
designed primarily to promote the public welfare, of the type permitted
under paragraph (11) of section 5136 of the Revised Statutes of the
United States (12 U.S.C. 24), including the welfare of low- and
moderate-income communities or families (such as providing housing,
services, or jobs);
(vi) A section 2(h)(2) company; or
(vii) A DPC branch subsidiary.
(c) Covered QFCs. For purposes of this subpart, a covered QFC is:
(1) With respect to a covered entity that is a covered entity on
November 13, 2017, an in-scope QFC that the covered entity:
(i) Enters, executes, or otherwise becomes a party to on or after
January 1, 2019; or
(ii) Entered, executed, or otherwise became a party to before
January 1, 2019, if the covered entity or any affiliate that is a
covered entity or excluded bank also enters, executes, or otherwise
becomes a party to a QFC with the same person or a consolidated
affiliate of the same person on or after January 1, 2019.
(2) With respect to a covered entity that becomes a covered entity
after November 13, 2017, an in-scope QFC that the covered entity:
(i) Enters, executes or otherwise becomes a party to on or after
the later of the date the covered entity first becomes a covered entity
and January 1, 2019; or
(ii) Entered, executed, or otherwise became a party to before the
date identified in paragraph (c)(2)(i) of this section with respect to
the covered entity, if the covered entity or any affiliate that is a
covered entity or excluded bank also enters, executes, or otherwise
becomes a party to a QFC with the same person or consolidated affiliate
of the same person on or after the date identified in paragraph
(c)(2)(i) with respect to the covered entity.
(d) In-scope QFCs. An in-scope QFC is a QFC that explicitly:
(1) Restricts the transfer of a QFC (or any interest or obligation
in or under, or any property securing, the QFC) from a covered entity;
or
(2) Provides one or more default rights with respect to a QFC that
may be exercised against a covered entity.
(e) Rules of construction. For purposes of this subpart:
(1) A covered entity does not become a party to a QFC solely by
acting as agent with respect to the QFC; and
(2) The exercise of a default right with respect to a covered QFC
includes the automatic or deemed exercise of the default right pursuant
to the terms of the QFC or other arrangement.
(f) Initial applicability of requirements for covered QFCs. (1)
With respect to each of its covered QFCs, a covered entity that is a
covered entity on November 13, 2017 must conform the covered QFC to the
requirements of this subpart by:
[[Page 42923]]
(i) January 1, 2019, if each party to the covered QFC is a covered
entity or an excluded bank;
(ii) July 1, 2019, if each party to the covered QFC (other than the
covered entity) is a financial counterparty that is not a covered
entity or excluded bank; or
(iii) January 1, 2020, if a party to the covered QFC (other than
the covered entity) is not described in paragraph (f)(1)(i) or
(f)(1)(ii) of this section or if, notwithstanding paragraph (f)(1)(ii),
a party to the covered QFC (other than the covered entity) is a small
financial institution.
(2) With respect to each of its covered QFCs, a covered entity that
is not a covered entity on November 13, 2017 must conform the covered
QFC to the requirements of this subpart by:
(i) The first day of the calendar quarter immediately following 1
year after the date the covered entity first becomes a covered entity,
if each party to the covered QFC is a covered entity or an excluded
bank;
(ii) The first day of the calendar quarter immediately following 18
months from the date the covered entity first becomes a covered entity
if each party to the covered QFC (other than the covered entity) is a
financial counterparty that is not a covered entity or excluded bank;
or
(iii) The first day of the calendar quarter immediately following 2
years from the date the covered entity first becomes a covered entity
if a party to the covered QFC (other than the covered entity) is not
described in paragraph (f)(2)(i) or (f)(2)(ii) of this section or if,
notwithstanding paragraph (f)(2)(ii), a party to the covered QFC (other
than the covered entity) is a small financial institution.
Sec. 252.83 U.S. Special Resolution Regimes.
(a) Covered QFCs not required to be conformed. (1) Notwithstanding
Sec. 252.82, a covered entity is not required to conform a covered QFC
to the requirements of this section if:
(i) The covered QFC designates, in the manner described in
paragraph (a)(2) of this section, the U.S. special resolution regimes
as part of the law governing the QFC; and
(ii) Each party to the covered QFC, other than the covered entity,
is:
(A) An individual that is domiciled in the United States, including
any State;
(B) A company that is incorporated in or organized under the laws
of the United States or any State;
(C) A company the principal place of business of which is located
in the United States, including any State; or
(D) A U.S. branch or U.S. agency.
(2) A covered QFC designates the U.S. special resolution regimes as
part of the law governing the QFC if the covered QFC:
(i) Explicitly provides that the covered QFC is governed by the
laws of the United States or a state of the United States; and
(ii) Does not explicitly provide that one or both of the U.S.
special resolution regimes, or a broader set of laws that includes a
U.S. special resolution regime, is excluded from the laws governing the
covered QFC.
(b) Provisions required. A covered QFC must explicitly provide
that:
(1) In the event the covered entity becomes subject to a proceeding
under a U.S. special resolution regime, the transfer of the covered QFC
(and any interest and obligation in or under, and any property
securing, the covered QFC) from the covered entity will be effective to
the same extent as the transfer would be effective under the U.S.
special resolution regime if the covered QFC (and any interest and
obligation in or under, and any property securing, the covered QFC)
were governed by the laws of the United States or a state of the United
States; and
(2) In the event the covered entity or an affiliate of the covered
entity becomes subject to a proceeding under a U.S. special resolution
regime, default rights with respect to the covered QFC that may be
exercised against the covered entity are permitted to be exercised to
no greater extent than the default rights could be exercised under the
U.S. special resolution regime if the covered QFC were governed by the
laws of the United States or a state of the United States.
(c) Relevance of creditor protection provisions. The requirements
of this section apply notwithstanding paragraphs (d), (f), and (h) of
Sec. 252.84.
Sec. 252.84 Insolvency proceedings.
(a) Covered QFCs not required to be conformed. Notwithstanding
Sec. 252.82, a covered entity is not required to conform a covered QFC
to the requirements of this section if the covered QFC:
(1) Does not explicitly provide any default right with respect to
the covered QFC that is related, directly or indirectly, to an
affiliate of the direct party becoming subject to a receivership,
insolvency, liquidation, resolution, or similar proceeding; and
(2) Does not explicitly prohibit the transfer of a covered
affiliate credit enhancement, any interest or obligation in or under
the covered affiliate credit enhancement, or any property securing the
covered affiliate credit enhancement to a transferee upon or following
an affiliate of the direct party becoming subject to a receivership,
insolvency, liquidation, resolution, or similar proceeding or would
prohibit such a transfer only if the transfer would result in the
supported party being the beneficiary of the credit enhancement in
violation of any law applicable to the supported party.
(b) General prohibitions. (1) A covered QFC may not permit the
exercise of any default right with respect to the covered QFC that is
related, directly or indirectly, to an affiliate of the direct party
becoming subject to a receivership, insolvency, liquidation,
resolution, or similar proceeding.
(2) A covered QFC may not prohibit the transfer of a covered
affiliate credit enhancement, any interest or obligation in or under
the covered affiliate credit enhancement, or any property securing the
covered affiliate credit enhancement to a transferee upon or following
an affiliate of the direct party becoming subject to a receivership,
insolvency, liquidation, resolution, or similar proceeding unless the
transfer would result in the supported party being the beneficiary of
the credit enhancement in violation of any law applicable to the
supported party.
(c) Definitions relevant to the general prohibitions--(1) Direct
party. Direct party means a covered entity or excluded bank that is a
party to the direct QFC.
(2) Direct QFC. Direct QFC means a QFC that is not a credit
enhancement, provided that, for a QFC that is a master agreement that
includes an affiliate credit enhancement as a supplement to the master
agreement, the direct QFC does not include the affiliate credit
enhancement.
(3) Affiliate credit enhancement. Affiliate credit enhancement
means a credit enhancement that is provided by an affiliate of a party
to the direct QFC that the credit enhancement supports.
(d) General creditor protections. Notwithstanding paragraph (b) of
this section, a covered direct QFC and covered affiliate credit
enhancement that supports the covered direct QFC may permit the
exercise of a default right with respect to the covered QFC that arises
as a result of:
(1) The direct party becoming subject to a receivership,
insolvency, liquidation, resolution, or similar proceeding;
(2) The direct party not satisfying a payment or delivery
obligation pursuant to the covered QFC or another contract between the
same parties that gives rise to a default right in the covered QFC; or
[[Page 42924]]
(3) The covered affiliate support provider or transferee not
satisfying a payment or delivery obligation pursuant to a covered
affiliate credit enhancement that supports the covered direct QFC.
(e) Definitions relevant to the general creditor protections--(1)
Covered direct QFC. Covered direct QFC means a direct QFC to which a
covered entity or excluded bank is a party.
(2) Covered affiliate credit enhancement. Covered affiliate credit
enhancement means an affiliate credit enhancement in which a covered
entity or excluded bank is the obligor of the credit enhancement.
(3) Covered affiliate support provider. Covered affiliate support
provider means, with respect to a covered affiliate credit enhancement,
the affiliate of the direct party that is obligated under the covered
affiliate credit enhancement and is not a transferee.
(4) Supported party. Supported party means, with respect to a
covered affiliate credit enhancement and the direct QFC that the
covered affiliate credit enhancement supports, a party that is a
beneficiary of the covered affiliate support provider's obligation(s)
under the covered affiliate credit enhancement.
(f) Additional creditor protections for supported QFCs.
Notwithstanding paragraph (b) of this section, with respect to a
covered direct QFC that is supported by a covered affiliate credit
enhancement, the covered direct QFC and the covered affiliate credit
enhancement may permit the exercise of a default right after the stay
period that is related, directly or indirectly, to the covered
affiliate support provider becoming subject to a receivership,
insolvency, liquidation, resolution, or similar proceeding if:
(1) The covered affiliate support provider that remains obligated
under the covered affiliate credit enhancement becomes subject to a
receivership, insolvency, liquidation, resolution, or similar
proceeding, other than a Chapter 11 proceeding;
(2) Subject to paragraph (h) of this section, the transferee, if
any, becomes subject to a receivership, insolvency, liquidation,
resolution, or similar proceeding;
(3) The covered affiliate support provider does not remain, and a
transferee does not become, obligated to the same, or substantially
similar, extent as the covered affiliate support provider was obligated
immediately prior to entering the receivership, insolvency,
liquidation, resolution, or similar proceeding with respect to:
(i) The covered affiliate credit enhancement;
(ii) All other covered affiliate credit enhancements provided by
the covered affiliate support provider in support of other covered
direct QFCs between the direct party and the supported party under the
covered affiliate credit enhancement referenced in paragraph (f)(3)(i)
of this section; and
(iii) All covered affiliate credit enhancements provided by the
covered affiliate support provider in support of covered direct QFCs
between the direct party and affiliates of the supported party
referenced in paragraph (f)(3)(ii) of this section; or
(4) In the case of a transfer of the covered affiliate credit
enhancement to a transferee,
(i) All of the ownership interests of the direct party directly or
indirectly held by the covered affiliate support provider are not
transferred to the transferee; or
(ii) Reasonable assurance has not been provided that all or
substantially all of the assets of the covered affiliate support
provider (or net proceeds therefrom), excluding any assets reserved for
the payment of costs and expenses of administration in the
receivership, insolvency, liquidation, resolution, or similar
proceeding, will be transferred or sold to the transferee in a timely
manner.
(g) Definitions relevant to the additional creditor protections for
supported QFCs--(1) Stay period. Stay period means, with respect to a
receivership, insolvency, liquidation, resolution, or similar
proceeding, the period of time beginning on the commencement of the
proceeding and ending at the later of 5:00 p.m. (eastern time) on the
business day following the date of the commencement of the proceeding
and 48 hours after the commencement of the proceeding.
(2) Business day. Business day means a day on which commercial
banks in the jurisdiction the proceeding is commenced are open for
general business (including dealings in foreign exchange and foreign
currency deposits).
(3) Transferee. Transferee means a person to whom a covered
affiliate credit enhancement is transferred upon the covered affiliate
support provider entering a receivership, insolvency, liquidation,
resolution, or similar proceeding or thereafter as part of the
resolution, restructuring, or reorganization involving the covered
affiliate support provider.
(h) Creditor protections related to FDI Act proceedings.
Notwithstanding paragraphs (b), (d), and (f) of this section, with
respect to a covered direct QFC that is supported by a covered
affiliate credit enhancement, the covered direct QFC and the covered
affiliate credit enhancement may permit the exercise of a default right
that is related, directly or indirectly, to the covered affiliate
support provider becoming subject to FDI Act proceedings:
(1) After the FDI Act stay period, if the covered affiliate credit
enhancement is not transferred pursuant to 12 U.S.C. 1821(e)(9)-(e)(10)
and any regulations promulgated thereunder; or
(2) During the FDI Act stay period, if the default right may only
be exercised so as to permit the supported party under the covered
affiliate credit enhancement to suspend performance with respect to the
supported party's obligations under the covered direct QFC to the same
extent as the supported party would be entitled to do if the covered
direct QFC were with the covered affiliate support provider and were
treated in the same manner as the covered affiliate credit enhancement.
(i) Prohibited terminations. A covered QFC must require, after an
affiliate of the direct party has become subject to a receivership,
insolvency, liquidation, resolution, or similar proceeding:
(1) The party seeking to exercise a default right to bear the
burden of proof that the exercise is permitted under the covered QFC;
and
(2) Clear and convincing evidence or a similar or higher burden of
proof to exercise a default right.
Sec. 252.85 Approval of enhanced creditor protection conditions.
(a) Protocol compliance. (1) Unless the Board determines otherwise
based on the specific facts and circumstances, a covered QFC is deemed
to comply with this subpart if it is amended by the universal protocol
or the U.S. protocol.
(2) A covered QFC will be deemed to be amended by the universal
protocol for purposes of paragraph (a)(1) of this section
notwithstanding the covered QFC being amended by one or more Country
Annexes, as the term is defined in the universal protocol.
(3) For purposes of paragraphs (a)(1) and (2) of this section:
(i) The universal protocol means the ISDA 2015 Universal Resolution
Stay Protocol, including the Securities Financing Transaction Annex and
Other Agreements Annex, published by the International Swaps and
Derivatives Association, Inc., as of May 3, 2016, and minor or
technical amendments thereto;
(ii) The U.S. protocol means a protocol that is the same as the
universal protocol other than as
[[Page 42925]]
provided in paragraphs (a)(3)(ii)(A)-(F) of this section.
(A) The provisions of Section 1 of the attachment to the universal
protocol may be limited in their application to covered entities and
excluded banks and may be limited with respect to resolutions under the
Identified Regimes, as those regimes are identified by the universal
protocol;
(B) The provisions of Section 2 of the attachment to the universal
protocol may be limited in their application to covered entities and
excluded banks;
(C) The provisions of Section 4(b)(i)(A) of the attachment to the
universal protocol must not apply with respect to U.S. special
resolution regimes;
(D) The provisions of Section 4(b) of the attachment to the
universal protocol may only be effective to the extent that the covered
QFCs affected by an adherent's election thereunder would continue to
meet the requirements of this subpart;
(E) The provisions of Section 2(k) of the attachment to the
universal protocol must not apply; and
(F) The U.S. protocol may include minor and technical differences
from the universal protocol and differences necessary to conform the
U.S. protocol to the differences described in paragraphs (a)(3)(ii)(A)-
(E) of this section;
(iii) Amended by the universal protocol or the U.S. protocol, with
respect to covered QFCs between adherents to the protocol, includes
amendments through incorporation of the terms of the protocol (by
reference or otherwise) into the covered QFC; and
(iv) The attachment to the universal protocol means the attachment
that the universal protocol identifies as ``ATTACHMENT to the ISDA 2015
UNIVERSAL RESOLUTION STAY PROTOCOL.''
(b) Proposal of enhanced creditor protection conditions. (1) A
covered entity may request that the Board approve as compliant with the
requirements of Sec. Sec. 252.83 and 252.84 proposed provisions of one
or more forms of covered QFCs, or proposed amendments to one or more
forms of covered QFCs, with enhanced creditor protection conditions.
(2) Enhanced creditor protection conditions means a set of limited
exemptions to the requirements of Sec. 252.84(b) that is different
than that of paragraphs (d), (f), and (h) of Sec. 252.84.
(3) A covered entity making a request under paragraph (b)(1) of
this section must provide:
(i) An analysis of the proposal that addresses each consideration
in paragraph (d) of this section;
(ii) A written legal opinion verifying that proposed provisions or
amendments would be valid and enforceable under applicable law of the
relevant jurisdictions, including, in the case of proposed amendments,
the validity and enforceability of the proposal to amend the covered
QFCs; and
(iii) Any other relevant information that the Board requests.
(c) Board approval. The Board may approve, subject to any
conditions or commitments the Board may set, a proposal by a covered
entity under paragraph (b) of this section if the proposal, as compared
to a covered QFC that contains only the limited exemptions in
paragraphs of (d), (f), and (h) of Sec. 252.84 or that is amended as
provided under paragraph (a) of this section, would prevent or mitigate
risks to the financial stability of the United States that could arise
from the failure of a global systemically important BHC, a global
systemically important foreign banking organization, or the
subsidiaries of either and would protect the safety and soundness of
bank holding companies and state member banks to at least the same
extent.
(d) Considerations. In reviewing a proposal under this section, the
Board may consider all facts and circumstances related to the proposal,
including:
(1) Whether, and the extent to which, the proposal would reduce the
resiliency of such covered entities during distress or increase the
impact on U.S. financial stability were one or more of the covered
entities to fail;
(2) Whether, and the extent to which, the proposal would materially
decrease the ability of a covered entity, or an affiliate of a covered
entity, to be resolved in a rapid and orderly manner in the event of
the financial distress or failure of the entity that is required to
submit a resolution plan;
(3) Whether, and the extent to which, the set of conditions or the
mechanism in which they are applied facilitates, on an industry-wide
basis, contractual modifications to remove impediments to resolution
and increase market certainty, transparency, and equitable treatment
with respect to the default rights of non-defaulting parties to a
covered QFC;
(4) Whether, and the extent to which, the proposal applies to
existing and future transactions;
(5) Whether, and the extent to which, the proposal would apply to
multiple forms of QFCs or multiple covered entities;
(6) Whether the proposal would permit a party to a covered QFC that
is within the scope of the proposal to adhere to the proposal with
respect to only one or a subset of covered entities;
(7) With respect to a supported party, the degree of assurance the
proposal provides to the supported party that the material payment and
delivery obligations of the covered affiliate credit enhancement and
the covered direct QFC it supports will continue to be performed after
the covered affiliate support provider enters a receivership,
insolvency, liquidation, resolution, or similar proceeding;
(8) The presence, nature, and extent of any provisions that require
a covered affiliate support provider or transferee to meet conditions
other than material payment or delivery obligations to its creditors;
(9) The extent to which the supported party's overall credit risk
to the direct party may increase if the enhanced creditor protection
conditions are not met and the likelihood that the supported party's
credit risk to the direct party would decrease or remain the same if
the enhanced creditor protection conditions are met; and
(10) Whether the proposal provides the counterparty with additional
default rights or other rights.
Sec. 252.86 Foreign bank multi-branch master agreements.
(a) Treatment of foreign bank multi-branch master agreements. With
respect to a U.S. branch or U.S. agency of a global systemically
important foreign banking organization, a foreign bank multi-branch
master agreement that is a covered QFC solely because the master
agreement permits agreements or transactions that are QFCs to be
entered into at one or more U.S. branches or U.S. agencies of the
global systemically important foreign banking organization will be
considered a covered QFC for purposes of this subpart only with respect
to such agreements or transactions booked at such U.S. branches and
U.S. agencies.
(b) Definition of foreign bank multi-branch master agreements. A
foreign bank multi-branch master agreement means a master agreement
that permits a U.S. branch or U.S. agency and another place of business
of a foreign bank that is outside the United States to enter
transactions under the agreement.
Sec. 252.87 Identification of global systemically important foreign
banking organizations.
(a) For purposes of this subpart, a top-tier foreign banking
organization that is
[[Page 42926]]
or controls a covered company (as defined at 12 CFR 243.2(f)) is a
global systemically important foreign banking organization if any of
the following conditions is met:
(1) The top-tier foreign banking organization determines, pursuant
to paragraph (c) of this section, that the top-tier foreign banking
organization has the characteristics of a global systemically important
banking organization under the global methodology; or
(2) The Board, using information available to the Board,
determines:
(i) That the top-tier foreign banking organization would be a
global systemically important banking organization under the global
methodology;
(ii) That the top-tier foreign banking organization, if it were
subject to the Board's Regulation Q (part 217 of this chapter), would
be identified as a global systemically important BHC under Sec.
217.402 of the Board's Regulation Q; or
(iii) That any U.S. intermediate holding company controlled by the
top-tier foreign banking organization, if the U.S. intermediate holding
company is or were subject to Sec. 217.402 of the Board's Regulation
Q, is or would be identified as a global systemically important BHC.
(b) Each top-tier foreign banking organization that determines
pursuant to paragraph (c) of this section that it has the
characteristics of a global systemically important banking organization
under the global methodology must notify the Board of the determination
by January 1 of each calendar year.
(c) A top-tier foreign banking organization that is or controls a
covered company (as defined at 12 CFR 243.2(f)) and prepares or reports
for any purpose the indicator amounts necessary to determine whether
the top-tier foreign banking organization is a global systemically
important banking organization under the global methodology must use
the data to determine whether the top-tier foreign banking organization
has the characteristics of a global systemically important banking
organization under the global methodology.
(d) Each top-tier foreign banking organization that controls a U.S.
intermediate holding company and that meets the requirements of Sec.
252.153(b)(5) and (6) also meets the requirements of paragraphs (b) and
(c) of this section.
Sec. 252.88 Exclusion of certain QFCs.
(a) Exclusion of QFCs with FMUs. Notwithstanding Sec. 252.82, a
covered entity is not required to conform to the requirements of this
subpart a covered QFC to which:
(1) A CCP is party; or
(2) Each party (other than the covered entity) is an FMU.
(b) Exclusion of certain excluded bank QFCs. If a covered QFC is
also a covered QFC under parts 47 or 382 of this title that an
affiliate of the covered entity is also required to conform pursuant to
parts 47 or 382 of this title and the covered entity is:
(1) The affiliate credit enhancement provider with respect to the
covered QFC, then the covered entity is required to conform the credit
enhancement to the requirements of this subpart but is not required to
conform the direct QFC to the requirements of this subpart; or
(2) The direct party to which the excluded bank is the affiliate
credit enhancement provider, then the covered entity is required to
conform the direct QFC to the requirements of this subpart but is not
required to conform the credit enhancement to the requirements of this
subpart.
(c) Exclusion of certain contracts. Notwithstanding Sec. 252.82, a
covered entity is not required to conform the following types of
contracts or agreements to the requirements of this subpart:
(1) An investment advisory contract that:
(i) Is with a retail customer or counterparty;
(ii) Does not explicitly restrict the transfer of the contract (or
any QFC entered pursuant thereto or governed thereby, or any interest
or obligation in or under, or any property securing, any such QFC or
the contract) from the covered entity except as necessary to comply
with section 205(a)(2) of the Investment Advisers Act of 1940 (15
U.S.C. 80b-5(a)(2)); and
(iii) Does not explicitly provide a default right with respect to
the contract or any QFC entered pursuant thereto or governed thereby.
(2) A warrant that:
(i) Evidences a right to subscribe to or otherwise acquire a
security of the covered entity or an affiliate of the covered entity;
and
(ii) Was issued prior to November 13, 2017.
(d) Exemption by order. The Board may exempt by order one or more
covered entities from conforming one or more contracts or types of
contracts to one or more of the requirements of this subpart after
considering:
(1) The potential impact of the exemption on the ability of the
covered entity(ies), or affiliates of the covered entity(ies), to be
resolved in a rapid and orderly manner in the event of the financial
distress or failure of the entity that is required to submit a
resolution plan;
(2) The burden the exemption would relieve; and
(3) Any other factor the Board deems relevant.
By order of the Board of Governors of the Federal Reserve
System, September 1, 2017.
Ann E. Misback,
Secretary of the Board.
[FR Doc. 2017-19053 Filed 9-11-17; 8:45 am]
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