FDIC Restricts QFC Cancellation Rights
The FDIC adopted a final rule that restricts cancellation rights for qualified financial contracts when a counterparty enters into bankruptcy or resolution proceedings. The final rule requires FDIC-supervised institutions and their subsidiaries ("covered FSIs") that are affiliated with U.S. or foreign global systemically important banking institutions ("GSIBs") to amend qualified financial contracts ("QFCs") so that they cannot be cancelled immediately in the event of a bankruptcy or a resolution process involving the FSI or its affiliates. Covered QFCs include OTC derivatives, securities contracts (e.g., securities loans and forwards and margin loans), commodities forward contracts and repurchase agreements. The language of the final rule is "substantively identical" to the rule recently adopted by the Board of Governors of the Federal Reserve System ("FRB") (see previous coverage) and covers certain state-chartered banks that are not members of the Federal Reserve System, state-chartered savings associations, state-licensed branches of foreign banks for which the FDIC is the primary federal regulator, as well as subsidiaries.
The final rule becomes effective on January 1, 2018. In agreement with the FRB rule, covered FSIs will be required to ensure that QFCs are in compliance with the new requirements if executed after the applicable compliance dates:
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January 1, 2019, in the case of QFCs in which each counterparty is a covered entity subject to one of the bank regulators' rules.
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July 1, 2019, in the case of QFCs in which the counterparty is a financial institution that is not (i) a covered entity subject to one of the bank regulators' rules or (ii) a small bank/small financial institution.
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January 1, 2020 in the case of QFCs involving all other counterparties.
In addition, covered FSIs are required to bring legacy QFCs, executed prior to the relevant compliance date, into compliance at the same time that it or a covered affiliate enters into a new QFC with the relevant counterparty or a consolidated affiliate of that counterparty that is subject to the requirements.
Commentary
As noted by the FDIC, this rule is part of a coordinated effort with the FRB and is intended to extend identical requirements to members of GSIBs that the FRB doesn't cover. As with the FRB rulemaking, the FDIC's cost/benefit analysis largely amounted to an argument that cost was irrelevant. It is undeniable that the financial crisis was enormously costly. It is debatable, however, whether boot-strapping industry-wide contract requirements onto current bankruptcy/insolvency law is the best way to address the systemic risk concerns. After all, these are not small or simple repapering efforts. Laws have been known to change. Additional repaperings may be required in the future if the terms that work today become outdated.