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From Banking and Finance Law Daily, September 28, 2017

FDIC-supervised institutions subject to restrictions on qualified financial contracts

By Lisa M. Goolik, J.D.

The Federal Deposit Insurance Corporation has adopted a final rule to enhance financial stability by requiring state savings associations and banks supervised by the FDIC that are affiliated with U.S. global systemically important banking organizations (GSIBs) and the U.S. operations of foreign GSIBs to ensure that their qualified financial contracts (QFCs) do not allow for immediate cancellation or termination if the firm enters bankruptcy or a resolution process. The final rule takes effect Jan. 1, 2018; however, the FDIC is adopting a phased-in approach for compliance, beginning Jan. 1, 2019.

The risk of QFCs. QFCs—which include derivatives, securities lending, and short-term funding transactions—can pose a threat to financial stability in times of market stress. The purpose of the final rule is to improve the orderly resolution of a GSIB by limiting disruptions to a failed GSIB through its subsidiaries’ financial contracts with other companies. The rule is intended to work in tandem with a final rule adopted by the Federal Reserve Board on Sept. 1, 2017, and an expected final rule to be released by the Office of the Comptroller of the Currency.

QFC requirements. The final rule requires that QFCs of covered FDIC-supervised institutions, including those with foreign counterparties, clarify that they are subject to temporary stays under U.S. resolution regimes.

In addition, covered FDIC-supervised institutions are prohibited from being a party to a QFC that would allow a QFC to exercise default rights against, or impose transfer restrictions on, the covered FDIC-supervised institution based on the entry of an affiliate of the covered FDIC-supervised institution into bankruptcy.

The final rule excludes QFCs that do not contain default rights or restrictions that could undermine the orderly resolution of a GSIB. The final rule also excludes certain retail investment advisory agreements and certain existing warrants.

Definitions amended. The final rule also amends the definitions of "qualifying master netting agreement" and related terms in the FDIC's capital and liquidity rules to account for the final rule. The amendments are intended to ensure that the regulatory capital and liquidity treatment of QFCs to which a covered FSI is party would not be affected by the restrictions on such QFCs.

Compliance period. Identical to the Fed’s final rule, the FDIC has adopted a transition period for compliance based on the type of counterparty. The final rule provides that covered FDIC-supervised institutions must conform a covered QFC to the rule’s requirement by Jan. 1, 2019, with respect to covered QFCs with other covered FDIC-supervised institutions, covered entities, and covered banks. The FDIC said the provision allows the counterparties, who should be the most familiar with the requirements of the final rule, over one year to comply with the rule’s requirements. Moreover, said the FDIC, this is a relatively small number of counterparties that would need to modify their QFCs.

For other types of financial counterparties, other than small financial institutions, covered FDIC-supervised institutions must comply with the requirements by July 1, 2019. Smaller banks and other non-financial counterparties, will have until Jan. 1, 2020 to comply.

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