FRB Provides Lincoln (Push Out) Relief to U.S. Branches of Non-U.S. Banks (Regulation KK)

The long-overdue Interim Rule seeks to resolve one of the most widely acknowledged errors in the drafting of the Dodd-Frank Act.

The Lincoln Amendment, as originally drafted, prohibited certain swaps activities in any entity that obtained an "advance" from the Federal Reserve (including both FDIC-insured banks and U.S. branches of foreign banks, all of which have access to the Federal Reserve Discount Window). In Conference Committee, the prohibition in the Lincoln Amendment was amended to provide a number of exceptions for "insured depository institutions." These exceptions included the ability of insured depository institutions to apply for a two-year transition period (extendable for an additional year), the ability to retain swaps dealing activity in swaps involving bank-eligible assets (such as rate swaps, currency swaps and cleared credit default swaps), the ability to retain pre-effective date swaps, and the ability to enter into swaps for bona fide hedging purposes.

However, given that the common understanding of the term "insured depository institution" encompasses only FDIC-insured entities, the Conference Committee amendment raised the possibility that uninsured U.S. branches of foreign banks could not take advantage of the exemptions and therefore would be required to cease all swaps dealing activity prior to July 16, 2013, in order to prevent loss of access to the Federal Reserve's Discount Window. While members of Congress freely acknowledged that this discrepancy was a drafting error (including when used in statements made on the floor by Dodd-Frank co-sponsor Senator Chris Dodd and Lincoln Amendment author Senator Blanche Lincoln), no legislation was passed to fix the error.

The Federal Reserve's Interim Rule effectively places U.S. branches of foreign banks on equal footing with U.S. banks, at least for the time being. Because U.S. branches of foreign banks are being deemed "insured depository institutions" for Lincoln Amendment purposes, U.S. branches of foreign banks will be permitted to apply for the transition period; will be permitted to continue dealing in rate swaps, currency swaps, and cleared credit default swaps; can enter into hedging swaps; and will be permitted to retain pre-effective date swaps.

The Interim Rule does not address some of the other problematic aspects of the Lincoln Amendment, however. For example, there is some concern that swaps activity in the foreign bank's home office could be attributed to the branch and, therefore, the home office's non-bank-eligible swaps (such as commodity swaps or equity swaps) could jeopardize the branch's access to the Window, at least at the end of any transition period. Nor does the Interim Rule address the uncertainty as to what is meant by "advances" for purposes of the Lincoln Amendment. For example, while it is clear that "advances" include extensions of credit pursuant to the Fed's primary credit, secondary credit, and seasonal Discount Window programs, it is less clear whether "advances" include other credit arrangements, such as incidental credit in the Fedwire or Primary Dealer programs. Moreover, because the Lincoln Amendment bars the use of any advance for the purposes of making a loan to a registered swap dealer, it remains unclear whether the branch of a foreign bank may transfer Federal Reserve advance proceeds to its home office if the home office is a registered swap dealer. Hopefully these issues will be addressed by Congress or by the regulators before the two-year transition period announced today runs its course.

Regardless, U.S. branches of foreign banks can at least be relieved that they will not be compelled within the next 6 weeks to shut down all swaps activity or face the possible loss of access to the Discount Window - provided they promptly submit requests for the grant of a transition period, as authorized by today's Interim Rule.