Banking and Finance Law Daily Fed proposes restrictions on QFCs; approves NSFR proposal
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Tuesday, May 3, 2016

Fed proposes restrictions on QFCs; approves NSFR proposal

By John M. Pachkowski, J.D.

At its May 3, 2016, open meeting, the Federal Reserve Board approved two proposed rulemakings involving the implementation of a net stable funding ratio (NSFR) requirement for large banking organizations and the establishment of restrictions on qualified financial contracts (QFCs) of U.S. global systemically important banking organizations (GSIBs) and the U.S. operations of foreign GSIBs.

NSFR requirement. The net stable funding ratio requirement proposal is part of an interagency effort by the Fed, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation to limit over-reliance on short-term wholesale funding, encourage better assessment of funding risk across all on- and off-balance sheet items, and promote funding stability. The NSFR proposal would complement the liquidity coverage ratio rule, which requires large banking organizations to hold a minimum amount of high-quality liquid assets that can be easily and quickly converted into cash to meet net cash outflows over a 30-day stress period.

The FDIC’s board of directors had already approved the proposal at its April 26, 2016, meeting; and Thomas J. Curry indicated at that FDIC meeting that he had signed off on the proposal for the OCC (see Banking and Finance Law DailyApril 26, 2016).

QFC restrictions. The Fed’s approval of the proposed QFC restrictions is intended to address the threat to global financial stability posed by the disorderly unwind of a failed GSIB’s QFCs. Under the proposal, the QFCs of GSIBs would be required to contain contractual provisions that recognize the automatic stay of termination provisions and transfer provisions applied in resolutions under the Dodd-Frank Act and the Federal Deposit Insurance Act (FDI Act). The proposal would also generally require QFCs of GSIBs to prohibit a counterparty to the QFC from exercising default rights based on the entry into resolution of an affiliate of the GSIB.

A QFC would be any instrument defined in 12 U.S.C. §5390(c)(8)(D), which includes among other things, derivatives, repurchase agreements, reverse repurchase agreements, and securities lending and borrowing transactions.

"Covered entity". The proposal would apply to eight banking organizations in the U.S.—Bank of America Corp., Bank of New York Mellon Corp., Citigroup Inc., Financial Services Roundtable, Goldman Sachs Group Inc., JPMorgan Chase & Co., Morgan Stanley, State Street Corp., Wells Fargo & Co., as well as their subsidiaries. As for foreign GSIBs, their U.S. subsidiaries, U.S. branches, and U.S. agencies would also be covered by the proposed rulemaking. However, the Fed’s proposed rulemaking would not cover OCC-supervised entities, such as the national banks, since the OCC is expected to propose substantively identical restrictions on the QFCs of covered banks in the near future.

Complementary effort. The Fed noted that the proposed rulemaking would complement its recently proposed rule on total loss-absorbing capacity, long-term debt, and clean holding company requirements for U.S. GSIBs and the U.S. intermediate holding companies of foreign GSIBs. The agency added that the proposed rulemaking would also facilitate the implementation of the International Swaps and Derivatives Association 2015 Resolution Stay Protocol, which extends, through contractual agreement, the application of the resolution frameworks in the FDI Act and the Dodd-Frank Act to all QFCs entered into by a bank holding company and its subsidiaries, including QFCs entered into by covered entities outside the United States.

Reducing systemic impact. In a statement given at the meeting, Fed Chair Janet L. Yellen noted that the QFC proposal supported the Fed’s strategy to reduce the potential systemic impact of the failure of a large, interconnected banking organization. Fed Governor Daniel K. Tarullo called the QFC proposal "another step forward in our efforts to make financial firms resolvable without either injecting public capital or endangering the overall stability of the financial system."

Companies: Bank of America Corp.; Bank of New York Mellon Corp.; Citigroup Inc.; Financial Services Roundtable; Goldman Sachs Group Inc.; JPMorgan Chase & Co.; Morgan Stanley; State Street Corp.; Wells Fargo & Co.

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