FED proposes "stay and transfer" rule for swap counterparties
On May 3, the Federal Reserve Board proposed a rule intended to enhance the resolvability of large and complex banking organizations by limiting the ability of their counterparties to terminate "qualified financial contracts" such as uncleared derivatives, repos, reverse repos and securities lending and borrowing transactions.
The proposal would require eight U.S. banks that are deemed to be "global systemically important" to amend the terms of these types of contracts to prevent immediate cancellation if they enter into bankruptcy or a resolution process. The proposal effectively would prevent their counterparties from terminating the contracts for 48 hours, giving regulators time to conduct an orderly resolution of the bank.
The Fed said the proposal is intended to reduce the risk of a run on the solvent subsidiaries of a failed banking organization caused by a large number of firms terminating their financial contracts at the same time. Federal Reserve Chairman Janet Yellen explained that the financial crisis of 2008 showed that a run on a failing banking organization can begin with the "mass cancellation" of derivatives and repo contracts.
"That is why we are considering a proposal that would require very large banking organizations to use contracts that allow for a limited stay in resolution so that there is time to transfer QFCs from a failed firm to a solvent one," Yellen said. "This stay-and-transfer requirement will help manage the risk when a very large firm fails, and will thus strengthen the resiliency of the financial system as a whole."
The eight U.S. banks subject to the proposal are: Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JP Morgan Chase, Morgan Stanley, State Street and Wells Fargo. The proposal also would apply to the U.S. operations of 22 foreign banks of a similar size and importance to the global financial system.
Under current U.S. bankruptcy rules, these contracts are exempted from the automatic stay provisions of bankruptcy law that govern most other kinds of contracts. The Fed noted that the eight large U.S. banking organizations subject to the proposal have already signed up to a protocol developed by the International Swaps and Derivatives Association that applies the proposed "stay and transfer" approach to transactions with other systemically important banking organizations. The Fed's proposed rule would extend that approach to their transactions with all counterparties.
As proposed, the stay would not apply to contracts that are cleared through a central counterparty. The Fed said, however, that it is considering whether to propose a separate rule establishing "analogous" restrictions on cleared trades during the resolution of a large banking organization.
