# Mandatory Contractual Stay Requirements for Qualified Financial Contracts

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2017-25529

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** November 29, 2017
- **Citation:** 82 FR 56630

## Text

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Parts 3, 47 and 50
[Docket ID OCC-2016-0009]
RIN 1557-AE05
Mandatory Contractual Stay Requirements for Qualified Financial Contracts

AGENCY:

Office of the Comptroller of the Currency, Treasury (OCC).

ACTION:

Final rule.

SUMMARY:

The OCC is adopting a final rule that adds a new part to its rules to enhance the resilience and the safety and soundness of federally chartered and licensed financial institutions by addressing concerns relating to the exercise of default rights of certain financial contracts that could interfere with the orderly resolution of certain systemically important financial firms. Under the final rule, a covered bank is required to ensure that a covered qualified financial contract contains a contractual stay-and-transfer provision analogous to the statutory stay-and-transfer provision imposed under Title II of the Dodd-Frank, Wall Street Reform and Consumer Protection Act and in the Federal Deposit Insurance Act, and limits the exercise of default rights based on the insolvency of an affiliate of the covered bank. In addition, this final rule makes conforming amendments to the Capital Adequacy Standards and the Liquidity Risk Measurement Standards in its regulations. The requirements of this final rule are substantively identical to those adopted in the final rules issued by the Board of Governors of the Federal Reserve System and by the Federal Deposit Insurance Corporation.

DATES:

This final rule is effective on January 1, 2018.

FOR FURTHER INFORMATION CONTACT:

Valerie Song, Assistant Director, Scott Burnett, Attorney, or Colby Mangels, Attorney, Bank Activities and Structure Division, (202) 649-5500; Allison Hester-Haddad, Counsel, or Ron Shimabukuro, Senior Counsel, Legislative and Regulatory Activities Division, (202) 649-6282, 400 7th Street SW., Washington, DC 20219.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

A. Shared Policy Concerns of the Federal Banking Agencies

B. Specific Policy Concerns Affecting National Banks, FSAs and Federal Branches and Agencies

II. Background

A. Qualified Financial Contracts, Default Rights, and Financial Stability

B. QFC Default Rights and GSIB Resolution Strategies

C. Default Rights and Relevant Resolution Laws

III. Discussion of the Final Rule

A. Overview, Purpose, and Authority

B. Covered Banks

C. Covered QFCs

1. General Definition

2. Definition of Counterparty

3. Exclusion of Cleared QFCs and Financial Market Utilities

4. Exclusion of Certain QFCs Under Foreign Bank Multi-Branch Master Agreements

5. QFCs With Central Banks and Sovereign Entities

D. Definition of “Default Right”

E. Required Contractual Provisions Related to U.S. Special Resolution Regimes

F. Prohibited Cross-Default Rights

1. Definitions

2. General Prohibition

3. General Creditor Protections

4. Additional Creditor Protections for Supported QFCs

5. Creditor Protections Related to FDI Act Proceedings

6. Prohibited Terminations

7. Agency Transactions

8. Enforceability

9. Interaction With Other Regulatory Requirements

10. Compliance With the Universal Protocol

11. Compliance With the U.S. Protocol

G. Process for Approval of Enhanced Creditor Protections

1. Requests for Approval of Enhanced Creditor Protections

2. Compliance With the International Swaps and Derivatives Association (ISDA) 2015 Universal Resolution Stay Protocol and U.S. Protocol

H. Transition Periods

I. Revisions to Certain Definitions in the OCC's Capital and Liquidity Rules

IV. Regulatory Analysis

I. Introduction

In the wake of the financial crisis of 2007-2008, U.S. and international financial regulators have placed increased focus on improving the resolvability of large, complex financial institutions that operate in multiple jurisdictions, which are often referred to as global systemically important banking organizations (GSIBs). In connection with these ongoing efforts, the Office of the Comptroller of the Currency (OCC) and the Board of Governors of the Federal Reserve System (FRB) worked jointly to develop and issue two separate notice of proposed rulemakings (NPRMs). The FRB issued an NPRM on May 3, 2016 (FRB Proposed Rule); the OCC issued an NPRM on August 19, 2017 (OCC Proposed Rule).
1

The FRB Proposed Rule and the OCC Proposed Rule were substantively identical, with any differences generally relating to differences in the types of entities supervised by the FRB and OCC—the FRB Proposed Rule primarily addressed entities at the bank holding company level, while the OCC Proposed Rule addressed entities at the bank level (specifically, national banks, Federal savings associations (FSAs), and Federal branches and agencies). The Federal Deposit Insurance Corporation (FDIC) issued an NPRM on October 26, 2016, which paralleled the FRB Proposed Rule and the OCC Proposed Rule.
2

The OCC, FRB, and FDIC issued these NPRMs (hereinafter collectively referred to as the “Agencies' NPRMs”) as part of their ongoing efforts to improve the resolvability of U.S. GSIBs and Foreign GSIBs that operate in the United States.
3

1
81 FR 29169 (May 11, 2016) (Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions) (FRB Proposed Rule); 81 FR 55381 (August 19, 2017) (Mandatory Contractual Stay Requirements for Qualified Financial Contracts) (OCC Proposed Rule).

2
81 FR 74326 (October 26, 2016) (Restrictions on Qualified Financial Contracts of Certain FDIC-Supervised Institutions; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions) (FDIC Proposed Rule).

3
While the focus of the discussion in this preamble is on the impact of the OCC Proposed Rule specifically on national banks, FSAs, Federal branches and agencies, and generally on the national banking system, in light of the parallel nature of the OCC, FRB, and FDIC NPRMs, portions of the discussion in this preamble may be equally applicable to the FRB Proposed Rule and FDIC Proposed Rule.

The OCC received 21 comments on the proposed rule,
4

representing comments from banks and other financial institutions, trade associations, and individuals. Most of the comments submitted to the OCC were also submitted to the FRB and FDIC. As part of the effort to coordinate development of the final rules, all comments were shared among the Federal banking agencies (OCC, FRB, and FDIC).

4
Unless otherwise noted, any reference to the “proposed rule” in this preamble is intended to refer to the OCC Proposed Rule.

The OCC has carefully reviewed all of the comments received. The proposed rule and the comments are discussed in Section III (Discussion of the Final Rule) of the preamble. The OCC notes that many of the comments submitted to the OCC also included attachments with the comments submitted to the FRB and FDIC. The OCC further notes that to the degree applicable, all comments submitted as attachments were treated

as comments on the OCC Proposed Rule. As such, for discussion purposes these comments may be recharacterized or otherwise paraphrased in this preamble to reflect the points applicable to this final rule. In some instances, however, the preamble may discuss a comment that is not directly relevant to this final rule but illustrates the interaction between this final rule and the final rules of the FRB and FDIC. This is likely to be the case with respect to comments submitted to the FRB that address broad policy issues, such as the systemic risk of GSIBs.

A. Shared Policy Concerns of the Federal Banking Agencies

At the most basic level, the collective purpose of Agencies' NPRMs is to address a common supervisory concern raised by the resolvability of large, complex financial institutions in the United States that operate in multiple jurisdictions and that are subject to different supervisory authorities.
5

The Agencies' NPRMs reflected the coordinated efforts by the Federal banking agencies to develop a comprehensive U.S. regulatory framework, designed to be implemented by the OCC, FRB, and FDIC to apply to all entities of a GSIB in the United States to address the threat to financial stability posed by the disorderly exercise of default rights contained in certain qualified financial contracts (QFCs).

5
This section is only intended to give a general overview of the NPRMs issued by the OCC, FRB, and FDIC. Please refer to the NPRMs and final rules of each of the Federal banking agencies for any specific issues.

The threat to financial stability arises because all GSIBs are interconnected with other financial firms, including other GSIBs, through large volumes of QFCs. The failure of one entity within a GSIB can trigger disruptive terminations of these contracts if the counterparties of both the failed entity and its affiliates exercise their contractual rights to terminate the contracts and liquidate collateral. These terminations, especially if many counterparties lose confidence in the GSIB quickly, can destabilize the financial system and potentially spark a financial crisis through several channels. For example, such terminations can destabilize the failed entity's otherwise solvent affiliates, causing them to weaken or fail with adverse consequences to their counterparties that can result in a chain reaction that ripples through the financial system. They also may result in “fire sales” of large volumes of financial assets, in particular, the collateral that secures the contracts, which can in turn weaken and cause stress for other firms by depressing the value of similar assets that they hold.

The Agencies' NPRMs, generally would require banking organizations that are covered by the NPRMs to ensure that their covered QFCs: (1) Contain a contractual stay-and-transfer provision analogous to the statutory stay-and-transfer provision imposed under Title II of the Dodd-Frank, Wall Street Reform and Consumer Protection Act (Dodd-Frank Act),
6

and in the Federal Deposit Insurance Act (FDI Act),
7

and (2) limit the exercise of default rights based on the insolvency of an affiliate of the financial firm.

6
12 U.S.C. 5390(c)(9) (empowering the FDIC to transfer QFCs); 12 U.S.C. 5390(c)(10)(B)(i)(I) (providing for a temporary stay that generally lasts until 5:00 p.m. eastern time on the business day following the appointment of the FDIC as receiver).

7

See
12 U.S.C. 1821(e)(8)-(10).

In the United States, the FDI Act and the Dodd-Frank Act create special resolution frameworks for failed financial firms that provide that the rights of a failed financial firm's counterparties to terminate their QFCs are temporarily stayed when the financial firm enters a resolution proceeding to allow for the transfer of the relevant obligations under the QFC to a solvent entity. By requiring covered QFCs to contain a contractual stay-and-transfer provision analogous to the statutory stay-and-transfer provision imposed under the FDI Act and Title II of the Dodd-Frank Act, the counterparties of QFCs have essentially contractually opted into the FDI Act and Title II of the Dodd-Frank Act temporary stay-and-transfer treatment. In this way, the Agencies' NPRMs address the concern that the statutory stay-and-transfer treatment would be challenged by a QFC counterparty, and might not be enforced by a court in a foreign jurisdiction.

With respect to the default rights based on the insolvency of an affiliate, the Agencies' NPRMs required covered QFCs to contain mandatory contractual provisions that would prohibit the counterparties of the QFCs from exercising default rights related, directly or indirectly, to the entry into resolution of an affiliate of the banking organizations covered by the NPRMs (cross-default rights), subject to certain creditor protection exceptions.

B. Specific Policy Concerns Affecting National Banks, FSAs and Federal Branches and Agencies

While the OCC shares many of the overall policy concerns discussed in Section I-A with the FRB and FDIC with respect to the resolvability of large, complex financial institutions in the United States, the primary focus of this final rule is specifically on the safety and soundness of national banks, FSAs, and Federal branches and agencies, as well as the overall stability of the Federal banking system,
8

as posed by the disorderly exercise of default rights contained in QFCs. As the primary regulator for national banks, FSAs, and Federal branches and agencies (generally referred to as “OCC-supervised institutions”), the OCC has a strong safety and soundness interest in preventing such a disorderly termination of QFCs upon a GSIB's entry into resolution proceedings. QFCs are typically entered into by various operating entities in the GSIB group, which will often include a large depository institution that is subject to the OCC's supervision. These OCC-supervised institutions typically are some of the largest entities by asset size in the GSIB group, and often a party to large volumes of QFCs, making these institutions highly interconnected with other large financial firms.
9

The exercise of default rights against an otherwise healthy national bank, FSA, or Federal branch or agency resulting from the failure of its affiliate, for example its top-tier U.S. holding company, may cause it to weaken or fail, and in turn spread contagion throughout the U.S. financial system, including the national banking system, by causing a chain of failures by other financial institutions—including other national banks, FSAs, or Federal branches or agencies—that are its QFC counterparties. Furthermore, if an OCC-supervised institution were to fail, it is imperative that the default rights triggered by such an event are exercised in an orderly manner, both by domestic and foreign counterparties, to ensure that financial contagion does not spread to other federally chartered and licensed institutions and beyond, throughout the Federal banking system.

8
The term “Federal banking system” refers to all OCC-supervised institutions, including national banks, FSAs, and Federal branches and agencies.

9
81 FR 29619, 29172 (“From the standpoint of financial stability, the most important of these operating subsidiaries are generally a U.S. insured depository institution, a U.S. broker-dealer, and similar entities organized in other countries.”).

Accordingly, OCC-supervised institutions that are affiliates or branches of U.S. GSIBs or Foreign GSIBs are exposed, through the interconnectedness of their QFCs and the QFCs of their affiliates, to destabilizing effects if their counterparties or the counterparties of their affiliates exercise default rights upon the entry into resolution of the

OCC-supervised institution or any affiliate of the OCC-supervised institution. These potential destabilizing effects are best addressed by requiring all GSIB entities to amend their QFCs to include contractual provisions designed to avoid such destabilization. As the primary supervisor of national banks, FSAs, and Federal branches and agencies, the OCC has a significant interest in preventing or mitigating these destabilizing effects on the safety and soundness of not just the OCC-supervised institutions within a GSIB group, but to all OCC-supervised institutions in the Federal banking system. Measures to improve financial stability and the probability of a successful resolution of a GSIB likely will affect the operations of the OCC-supervised institutions that are within the GSIB group.

The OCC believes that each of the Federal banking agencies share a collective interest to insure the orderly resolution of all entities that make up a GSIB group. This final rule represents the OCC's effort to help address this systemic issue with respect to OCC-supervised institutions. Consequently, for the reasons discussed in this preamble, the OCC is issuing this final rule, which imposes substantively identical requirements on national banks, FSAs, and Federal branches and agencies as those imposed by the FRB and FDIC final rules.
10

10
“Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions,” 82 FR 42882 (September 12, 2017) (FRB Final Rule).
See also
12 U.S.C. 5365(b)(4) (requiring the FRB to consult with each Financial Stability Oversight Council (FSOC) member that primarily supervises any subsidiary when any prudential standard is likely to have a “significant impact” on such subsidiary).

II. Background

The following background discussion describes in detail the financial contracts that are the subject of this final rule, the default rights often contained in such contracts, and impacts on financial stability resulting from the exercise of such default rights. This section also provides in more detail background information on the resolution strategies for GSIBs and how they fit within the resolution frameworks in the United States.

A. Qualified Financial Contracts, Default Rights, and Financial Stability

The final rule covers QFCs, which include swaps, other derivative contracts, repurchase agreements (repos) and reverse repos, and securities lending and borrowing agreements. GSIB entities enter into QFCs to borrow money to finance their investments, to lend money, to manage risk, to attempt to profit from market movements, and to enable their clients and counterparties to perform these financial activities.

QFCs play a role in economically valuable financial intermediation when markets are functioning normally. But they are also a major source of financial interconnectedness, which may pose a threat to financial stability in times of stress. The final rule focuses on one of the most serious threats to both a global systemically important bank holding company (BHC) and its covered banks' subsidiaries—the failure of a GSIB that is party to large volumes of QFCs, which are likely to include QFCs with counterparties that are themselves systemically important. By contract, a party to a QFC generally has the right to take certain actions if its counterparty defaults on the QFC (that is, if it fails to meet certain contractual obligations). Common default rights include the right to suspend performance of the non-defaulting party's obligations, the right to terminate or accelerate the contract, the right to set off amounts owed between the parties, and the right to seize and liquidate the defaulting party's collateral. In general, default rights allow a party to a QFC to reduce the credit risk associated with the QFC by granting it the right to exit the QFC and thereby reduce its exposure to its counterparty upon the occurrence of a specified condition, such as its counterparty's entry into resolution proceedings.

This final rule focuses on two distinct scenarios in which a non-defaulting party to a QFC is commonly able to exercise default rights. These two scenarios involve a default that occurs when either the defaulting party to the QFC or an affiliate of that party enters a resolution proceeding.
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11
This preamble uses phrases such as “entering a resolution proceeding” and “going into resolution” to refer to the concept of “becoming subject to a receivership, insolvency, liquidation, resolution, or similar proceeding.” These phrases refer to proceedings established by law to deal with a failed legal entity. In the context of the failure of a global systemically important BHC, the most relevant types of resolution proceeding include: (1) For most US-based legal entities, the bankruptcy process established by the U.S. Bankruptcy Code (Title 11, United States Code); (2) for U.S. insured depository institutions, a receivership administered by the FDIC under the FDI Act (12 U.S.C. 1821); (3) for companies whose “resolution under otherwise applicable Federal or State law would have serious adverse effects on the financial stability of the United States,” the Dodd-Frank Act's Orderly Liquidation Authority (12 U.S.C. 5383(b)(2)); and, (4) for entities based outside the United States, resolution proceedings created by foreign law.

The first scenario occurs when a legal entity that is itself a party to the QFC enters a resolution proceeding. This final rule refers to such a scenario as a “direct default” and refers to the contractual default rights that arise from a direct default as “direct default rights.”
12

12
For convenience, this preamble uses the general term “default” to refer specifically to a default that occurs when a QFC party or its affiliate enters a resolution proceeding.

The second scenario occurs when an affiliate of the legal entity that is a direct party to the QFC (such as the direct party's parent holding company) enters a resolution proceeding. This final rule refers to such a scenario as a “cross-default” and refers to contractual default rights that arise from a cross-default as “cross-default rights.” For example, a GSIB parent entity might guarantee the derivatives transactions of its subsidiaries and those derivatives contracts could contain cross-default rights against a subsidiary of the GSIB that would be triggered by the bankruptcy filing of the GSIB parent entity even though the subsidiary continues to meet all of its financial obligations.

Direct default rights and cross-default rights are referred to collectively in this final rule as “default rights.”

As noted in the OCC Proposed Rule, if a significant number of QFC counterparties exercise their default rights precipitously and in a manner that would impede an orderly resolution of a GSIB, all QFC counterparties and the broader financial system, including institutions supervised by the OCC, may potentially be worse off and less stable.

The destabilization can occur in several ways. First, counterparties' exercise of default rights may drain liquidity from the troubled GSIB, forcing it to sell off assets at depressed prices, both because the sales must be done in a short timeframe and because the elevated supply will push prices down. These asset “fire sales” may cause or deepen balance-sheet insolvency at the GSIB, reducing the amount that its other creditors can recover and thereby imposing losses on those creditors and threatening their solvency (and, indirectly, the solvency of their own creditors, and so on). The GSIB may also respond by withdrawing liquidity that it had offered to other firms, forcing them to engage in asset fire sales. Alternatively, if the GSIB's QFC counterparty itself liquidates the QFC collateral at fire sale prices, the effect will again be to weaken the GSIB's balance sheet, because the debt satisfied by the liquidation would be less than

what the value of the collateral would have been outside the fire sale context. The counterparty's set-off rights may allow it to further drain the GSIB's capital and liquidity by withholding payments owed to the GSIB. The GSIB may also have rehypothecated collateral that it received from QFC counterparties, for instance in back-to-back repo or securities lending transactions, in which case demands from those counterparties for the early return of their rehypothecated collateral could be especially disruptive.

The asset fire sales can also spread contagion throughout the financial system by increasing volatility and by lowering the value of similar assets held by other financial institutions, potentially causing them to suffer diminished market confidence in their own solvency, mark-to-market losses, margin calls, and creditor runs (which could lead to further fire sales, thereby worsening the contagion). Finally, the early terminations of derivatives upon which the defaulting GSIB relied on to hedge its risks could leave major risks unhedged, increasing the GSIB's probable losses going forward.

Where there are significant simultaneous terminations and these effects occur contemporaneously, such as upon the failure of a GSIB that is party to a large volume of QFCs, they may pose a substantial risk to financial stability. In short, QFC continuity is important for the orderly resolution of a GSIB so that the instability caused by asset fire sales can be avoided.
13

13
The FRB and the FDIC identified the exercise of default rights in financial contracts as a potential obstacle to orderly resolution in the context of resolution plans filed pursuant to § 165(d) of the Dodd-Frank Act, and accordingly, instructed the most systemically important firms to demonstrate that they are “amending, on an industry-wide and firm-specific basis, financial contracts to provide for a stay of certain early termination rights of external counterparties triggered by insolvency proceedings.” FRB and FDIC, “Agencies Provide Feedback on Second Round Resolution Plans of 'First-Wave' Filers” (August 5, 2014), available at
http://www.federalreserve.gov/newsevents/press/bcreg/20140805a.htm. See also
FRB and FDIC, “Agencies Provide Feedback on Resolution Plans of Three Foreign Banking Organizations” (March 23, 2015), available at
http://www.federalreserve.gov/newsevents/press/bcreg/20150323a.htm;
FRB and FDIC, “Guidance for 2013 165(d) Annual Resolution Plan Submissions by Domestic Covered Companies that Submitted Initial Resolution Plans in 2012” 5-6 (April 15, 2013), available at
http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20130415c2.pdf.

As will be discussed further, the final rule is primarily concerned only with default rights that run against a GSIB—that is, direct default rights and cross-default rights that arise from the entry into resolution of a GSIB. The final rule would not affect contractual default rights that a GSIB (or any other entity) may have against a counterparty that is not a GSIB. The OCC believes that this limited scope is appropriate because the risk posed to financial stability by the exercise of QFC default rights is greatest when the defaulting counterparty is a GSIB.

B. QFC Default Rights and GSIB Resolution Strategies

Under the Dodd-Frank Act, many complex GSIBs are required to submit resolution plans to the FRB and the FDIC, detailing how the company can be resolved in a rapid and orderly manner in the event of material financial distress or failure of the company. In response to these requirements, these firms have developed resolution strategies that, broadly speaking, fall into two categories: The single-point-of-entry (SPOE) strategy and the multiple-point-of-entry (MPOE) strategy. As noted in the FRB Proposed Rule, cross-default rights in QFCs pose a potential obstacle to the implementation of either of these strategies.

In an SPOE resolution, only a single legal entity—the GSIB's top-tier BHC—would enter a resolution proceeding. The losses that led to the GSIB's failure would be passed up from the operating subsidiaries that incurred the losses to the holding company and would then be imposed on the equity holders and unsecured creditors of the holding company through the resolution process. This strategy is designed to help ensure that the GSIB's subsidiaries remain adequately capitalized. An SPOE resolution could thereby prevent those operating subsidiaries from failing or entering resolution themselves and allow them to instead continue normal operations. The expectation that the holding company's equity holders and unsecured creditors would absorb the GSIB's losses in the event of failure would help to maintain the confidence of the operating subsidiaries' creditors and counterparties (including QFC counterparties), reducing their incentive to engage in potentially destabilizing funding runs or margin calls and thus lowering the risk of asset fire sales.

An SPOE proceeding can avoid the need for covered banks to be placed into receivership or similar proceedings, as they would continue to operate as going concerns, only if the parent's entry into resolution proceedings does not trigger the exercise of cross-default rights. Accordingly, this final rule, by limiting such cross-default rights based on an affiliate's entry into resolution proceedings, enables the SPOE strategy, and in turn, would assist in stabilizing both the covered bank and the Federal banking system.

This final rule is also intended to yield benefits for resolution under the MPOE strategy. Unlike the SPOE strategy, an MPOE strategy involves several entities in the GSIB group entering proceedings. For example, an MPOE strategy might involve a Foreign GSIB's U.S. intermediate holding company going into resolution or a GSIB's U.S. insured depository institution entering resolution under the FDI Act. Similar to the benefits associated with the SPOE strategy, this final rule would help support the continued operation of affiliates of an entity experiencing resolution to the extent the affiliate continues to perform on its QFCs.

C. Default Rights and Relevant Resolution Laws

In order to understand the connection between direct defaults, cross-defaults, the SPOE and MPOE resolution strategies, and the threats to financial stability discussed previously, it is necessary to understand how QFCs, and the default rights contained therein, are treated when an entity enters resolution. The following sections discuss the treatment of QFCs in greater detail under three U.S. resolution laws: The Bankruptcy Code, the Orderly Liquidation Authority (OLA), and the FDI Act. As discussed in these sections, each of these resolution laws has special provisions detailing the treatment of QFCs upon an entity's entry into such proceedings.

U.S. Bankruptcy Code.
While covered banks themselves are not subject to resolution under the Bankruptcy Code, in general, if a BHC were to fail, it would be resolved under the Bankruptcy Code. When an entity goes into resolution under the Bankruptcy Code, attempts by the creditors of the debtor to enforce their debts through any means other than participation in the bankruptcy proceeding (for instance, by suing in another court, seeking enforcement of a preexisting judgment, or seizing and liquidating collateral) are generally blocked by the imposition of an automatic stay, which generally persists throughout the bankruptcy proceeding.
14

A key purpose of the automatic stay, and of bankruptcy law in general, is to maximize the value of the bankruptcy estate and the creditors' ultimate recoveries by facilitating an orderly liquidation or restructuring of the debtor. As a result, the automatic stay addresses the collective action problem, in which the creditors' individual incentives to race to recover as much from the debtor as possible

before other creditors can do so, collectively cause a value-destroying disorderly liquidation of the debtor.
15

14

See
11 U.S.C. 362.

15

See, e.g., Aiello
v.
Providian Financial Corp.,
239 F.3d 876, 879 (7th Cir. 2001).

The Bankruptcy Code, however, largely exempts QFC counterparties of the debtor from the automatic stay through special “safe harbor” provisions.
16

Under these provisions, any contractual rights that a QFC counterparty has to terminate the contract, set off obligations, or liquidate collateral in response to a direct default or cross-default are not subject to the stay and may be exercised at any time.
17

16
The U.S. Bankruptcy Code does not use the term “qualified financial contract,” but the set of transactions covered by its safe harbor provisions closely tracks the set of transactions that fall within the definition of “qualified financial contract” used in Title II of the Dodd-Frank Act and in this final rule.
See
11 U.S.C. 362(b)(6), (7), (17), (27), 362(o), 555, 556, 559, 560, and 561.

17
The Bankruptcy Code does not itself confer any default rights upon QFC counterparties; it merely permits QFC counterparties to exercise certain contractual rights that they have under the terms of the QFC. This final rule does not restrict the exercise of any default rights that fall within the Bankruptcy Code's safe harbor provisions, which are described here to provide context.

Where the failed firm is a GSIB's holding company with covered banks that are going concerns and are party to large volumes of QFCs, the mass exercise of default rights under the QFCs based on the affiliate default represents a significant impediment to the SPOE resolution strategy.
18

This is because the failure of a covered bank's affiliate will trigger the mass exercise of cross-default rights against the covered bank, which will not be stayed by the affiliate's entry into bankruptcy proceedings. This can in turn lead to fire sales that could threaten the ongoing viability of the covered bank and the successful resolution of the particular GSIB—and thus could also pose a threat to the Federal banking system and broader financial system.

18
As noted previously, the MPOE strategy will similarly benefit from the override of cross-defaults. The SPOE strategy is used here for illustrative purposes only.

Special Resolution Regimes Under U.S. Law.
For purposes of this final rule, there are two special resolution regimes under U.S. law: Title II of the Dodd-Frank Act and the Orderly Liquidation Authority and the FDI Act. While these regimes both impose certain limitations on the ability of counterparties to exercise default rights—thus mitigating the potential for disorderly resolution due to the exercise by counterparties of such default rights—these limitations may not be applicable or clearly enforceable in certain contexts.

Title II of the Dodd-Frank Act and the Orderly Liquidation Authority.
Title II of the Dodd-Frank Act establishes an alternative resolution framework intended “to provide the necessary authority to liquidate failing financial companies that pose a significant risk to the financial stability of the United States in a manner that mitigates such risk and minimizes moral hazard.”
19

19
12 U.S.C. 5384(a) (section 204(a) of the Dodd-Frank Act).

As noted, although a failed BHC would generally be resolved under the Bankruptcy Code, Congress recognized that a U.S. financial company might fail under extraordinary circumstances, in which an attempt to resolve it through the bankruptcy process would have serious adverse effects on financial stability in the United States. Title II therefore authorizes the Secretary of the Treasury, upon the recommendation of other government agencies and a determination that several preconditions are met, to place a U.S. financial company into a receivership conducted by the FDIC as an alternative to bankruptcy.

Title II empowers the FDIC, when it acts as receiver in an OLA resolution, to protect financial stability against the QFC-related threats discussed previously. Title II addresses direct default rights in a number of ways. Title II empowers the FDIC to transfer the QFCs to a bridge financial company or some other financial company that is not in a resolution proceeding and should therefore be capable of performing under the QFCs.
20

To give the FDIC time to effect this transfer, Title II temporarily stays QFC counterparties of the failed entity from exercising termination, netting, and collateral liquidation rights “solely by reason of or incidental to” the failed entity's entry into OLA resolution, its insolvency, or its financial condition.
21

Once the QFCs are transferred in accordance with the statute, Title II permanently stays the exercise of those direct default rights based on the prior event of default and receivership.
22

20
12 U.S.C. 5390(c)(9).

21
12 U.S.C. 5390(c)(10)(B)(i)(I). This temporary stay generally lasts until 5:00 p.m. eastern time on the business day following the appointment of the FDIC as receiver.

22
If the QFCs are transferred to a solvent third party before the stay expires, the counterparty is permanently enjoined from exercising such rights based upon the appointment of the FDIC as receiver of the financial company (or the insolvency or financial condition of the financial company), but is not stayed from exercising such rights based upon other events of default. 12 U.S.C. 5390(c)(10)(B)(i)(II).

Title II addresses cross-default rights through a similar procedure. It empowers the FDIC “to enforce contracts of subsidiaries or affiliates” of the failed company that are guaranteed or otherwise supported by or linked to the covered financial company, notwithstanding any contractual right to cause the termination, liquidation, or acceleration of such contracts based solely on the insolvency, financial condition, or receivership of the failed company, so long as, if such contracts are guaranteed or otherwise supported by the covered financial company, the FDIC takes certain steps to protect the QFC counterparty's interests by the end of the business day following the company's entry into OLA resolution.
23

23
12 U.S.C. 5390(c)(16); 12 CFR 380.12.

These stay-and-transfer provisions of the Dodd-Frank Act go far to mitigate the threat posed by QFC default rights by preventing mass closeouts against the entity that has entered into OLA proceedings or its going concern affiliates. At the same time, they allow for appropriate protections for QFC counterparties of the failed financial company. They only stay the exercise of default rights based on the failed company's entry into resolution, the fact of its insolvency, or its financial condition. Further, the stay period is brief, unless the FDIC transfers the QFCs to another financial company that is not in resolution and should therefore be capable of performing under the QFCs.

Federal Deposit Insurance Act.
Under the FDI Act, a failing insured depository institution would generally enter a receivership administered by the FDIC. The FDI Act addresses direct default rights in the failed bank's QFCs with stay-and-transfer provisions that are substantially similar to the provisions of Title II of the Dodd-Frank Act as discussed.
24

However, the FDI Act does not address cross-default rights, leaving the QFC counterparties of the failed depository institution's affiliates free to exercise any contractual rights they may have to terminate, net, and liquidate collateral based on the depository institution's entry into resolution.

24

See
12 U.S.C. 1821(e)(8)-(10).

III. Discussion of the Final Rule

A. Overview, Purpose, and Authority

As discussed previously, the exercise of default rights by counterparties of a failed GSIB can have a significant impact on financial stability. This financial stability concern is necessarily intertwined with the safety and soundness of covered banks and the Federal banking system—the disorderly exercise of default rights can produce a sudden, contemporaneous threat to the safety and soundness of individual institutions throughout the system,

which in turn threatens the system as a whole. Accordingly, national banks, FSAs, and Federal branches and agencies are affected by financial instability—even if such instability is precipitated outside the Federal banking system—and can themselves also be sources of financial destabilization due to the interconnectedness of these institutions to each other and to other entities within the financial system. Thus, safety and soundness of individual national banks, FSAs, and Federal branches and agencies, the Federal banking system, and financial stability of the system as a whole are interconnected.

The purpose of this final rule is to enhance the safety and soundness of covered banks and the Federal banking system, thereby also bolstering financial stability generally, by addressing the two main issues raised by covered QFCs with the orderly resolution of these covered banks as generally previously described.

While Title II and the FDI Act empower the use of the QFC stay-and-transfer provisions, a court in a foreign jurisdiction may decline to enforce these important provisions. The final rule directly improves the safety and soundness of covered banks by clarifying the applicability of U.S. special resolution regimes to all counterparties, whether they are foreign or domestic. Although domestic entities are clearly subject to the temporary stay provisions of OLA and the FDI Act, these stays may be difficult to enforce in a cross-border context. As a result, domestic counterparties of a failed U.S. financial institution may be disadvantaged relative to foreign counterparties, as the domestic counterparties would be subject to the stay, and accompanying potential market volatility, while if the stay was not enforced by foreign authorities, foreign counterparties could close out immediately. Furthermore, a mass close out by such foreign counterparties would likely exacerbate market volatility, which in turn would likely magnify harm to the stayed U.S. counterparties' positions, which are likely to include other national banks and FSAs. This final rule would eliminate the potential for these adverse consequences by requiring covered banks to condition the exercise of default rights in covered contracts on the stay provisions of OLA and the FDI Act.

In spite of the QFC stay-and-transfer provisions in Title II and the FDI Act, the affiliates of a global systemically important BHC that goes into resolution under the Bankruptcy Code may face disruptions to their QFCs as their counterparties exercise cross-default rights. Thus, a healthy covered bank whose parent BHC entered resolution proceedings could fail due to its counterparties exercising cross-default rights. This is both a safety and soundness concern for the otherwise healthy covered bank, but it also has the additional negative effect of defeating the orderly resolution of the GSIB, since a key element of SPOE resolution in the United States is ensuring that critical operating subsidiaries—such as covered banks—continue to operate on a going concern basis. This final rule would address this issue by generally restricting the exercise of cross-default rights by counterparties against a covered bank.

Moreover, a disorderly resolution of the kind described could jeopardize not just the covered bank and the orderly resolution of its failed parent BHC, but all surviving counterparties, many of which are likely to be other national banks and other FSAs, regardless of size or interconnectedness, by harming the overall condition of the Federal banking system and the financial system as a whole. A disorderly resolution could result in additional defaults, fire sales of collateral, and other consequences likely to amplify the systemic fallout of the resolution of a covered bank.

The final rule is designed to minimize such disorder, and therefore enhance the safety and soundness of all individual national banks, FSAs, and Federal branches and agencies, the Federal banking system, and the broader financial system. This is particularly important because financial institutions are more sensitive than other firms to the overall health of the financial system.
25

25
The OCC, along with the FDIC and FRB, recently made this point in the swap margin notice of proposed rulemaking. 79 FR 57348, 57361 (September 24, 2014) (“Financial firms present a higher level of risk than other types of counterparties because the profitability and viability of financial firms is more tightly linked to the health of the financial system than other types of counterparties. Because financial counterparties are more likely to default during a period of financial stress, they pose greater systemic risk and risk to the safety and soundness of the covered swap entity.”).

The final rule covers the OCC-supervised operations of foreign banking organizations (FBOs) designated as systemically important, including national bank and FSA subsidiaries, as well as Federal branches and agencies, of these FBOs. As with a national bank or FSA subsidiary of a U.S. global systemically important BHC, the OCC believes that this final rule should apply to a national bank or FSA subsidiary of a global systematically important FBO for essentially the same reasons. While the national bank or FSA may not be considered systemically important itself, as part of a GSIB, the disorderly resolution of the covered national banks and FSAs could have a significant negative impact on the Federal banking system and on the U.S. financial system, in general.

Specifically, the final rule is designed to prevent the failure of a global systemically important FBO from disrupting the ongoing operations or orderly resolution of the covered bank by protecting the healthy national bank or FSA from the mass triggering of default rights by the QFC counterparties. Additionally, the application of this final rule to the QFCs of these national bank and FSA subsidiaries should avoid creating what may otherwise be an incentive for counterparties to concentrate QFCs in these firms because they are subject to fewer counterparty restrictions. Similarly, it is important to cover certain QFCs entered into by any Federal branch or agency of a global systemically important FBO in order to ensure the orderly resolution of these entities if the parent FBO were to be placed into resolution in its home jurisdiction.

The OCC is issuing this final rule under its authorities under the National Bank Act (12 U.S.C. 1
et seq.
), the Home Owners' Loan Act (12 U.S.C. 1461
et seq.
), and the International Banking Act of 1978 (12 U.S.C. 3101
et seq.
), including its general rulemaking authorities.
26

The OCC views the final rule as consistent with its overall statutory mandate of assuring the safety and soundness of entities subject to its supervision, including national banks, FSAs, and Federal branches and agencies.
27

26

See
12 U.S.C. 93a, 1463(a)(2), and 3108(a).

27

See
12 U.S.C. 1. This primary responsibility is also defined in various provisions throughout the OCC's express statutory authorities with respect to each institution type under their respective statutes.

In developing this final rule, the OCC reviewed and carefully considered all comments received on the OCC Proposed Rule as part of the notice and comment process. In addition, in light of the closely connected nature between BHC supervision and the supervision of national banks, FSAs, and Federal branches and agencies, and in order to maintain substantive consistency with the FRB Proposed Rule and FDIC Proposed Rule, the OCC reviewed comments received by the FRB and FDIC on their proposed rules to the degree such comments were relevant to

the substance of this final rule. In characterizing comments and the OCC responses to the commenters in this preamble, the OCC may reference and discuss comments received by the FRB and FDIC as comments to the OCC to the extent applicable to the substance of the OCC final rule.

B. Covered Banks (§ 47.3(a), (b), and (c))

OCC Proposed Rule.
28

The proposed rule applied to “covered banks.” The term “covered bank” was defined to include (i) any national bank or FSA that is a subsidiary of a global systemically important BHC that has been designated pursuant to subpart I of 12 CFR part 252 (FRB Regulation YY); or (ii) any national bank or FSA subsidiary, or Federal branch or agency of a global systemically important FBO that has been designated pursuant to subpart I of 12 CFR part 252 (FRB Regulation YY).

28
References in this preamble to the “proposed rule” refer to the OCC Proposed Rule unless otherwise specified.

The proposed rule defined global systemically important BHC and global systemically important FBO by cross-reference to newly added subpart I of 12 CFR part 252 of the FRB Proposed Rule. The list of banking organizations that meet the methodology proposed in the FRB Proposed Rule is currently the same set of banking organizations that meet the Basel Committee on Banking Supervision (BCBS) definition of a GSIB.
29

29
In November 2015, the Financial Stability Board and BCBS published a list of banks that meet the BCBS definition of a global systemically important bank (BCBS G-SIB) based on year-end 2014 data. A list based on year-end 2014 data was published November 3, 2015 (available at
http://www.fsb.org/wp-content/uploads/2015-update-of-list-of-global-systemically-important-banks-G-SIBs.pdf
). The U.S. top-tier BHCs that are currently identified as a BCBS G-SIB are Bank of America Corporation, Bank of New York Mellon Corporation, Citigroup Inc., Goldman Sachs Group, Inc., JP Morgan Chase & Co., Morgan Stanley, State Street Corporation, and Wells Fargo & Company.

Under the proposed rule, the term covered bank also included any subsidiary of a national bank, FSA, or Federal branch or agency. The definition of “subsidiary of covered bank” in the proposed rule was intended to mirror the definition of subsidiary in the FRB Regulation YY (12 CFR 252.82(b)(2) and (3)), and it was intended to be substantially the same as the FRB definition with respect to a subsidiary of a covered bank.
30

30
The Bank Holding Company Act (BHC Act) definition of control includes ownership, control or the power to vote 25 percent of any class of voting securities; control in any manner of the election of a majority of the directors or trustees of; or exercise of a controlling influence over the management or policies. 12 U.S.C. 1841.

Comments.
While commenters overall supported the purpose of the proposed rule, a few commenters urged the OCC not to expand the scope of covered banks to include non-GSIBs. The definition of covered bank in the proposed rule only applied to a national bank, FSA, or Federal branch or agency that is under a global systemically important BHC or FBO as designated by the FRB final rule. However, the OCC requested comment on whether an additional threshold should be added to the definition of covered bank to cover a national bank or FSA that is not under a BHC but may have total assets sufficiently large to require application of the final rule. As discussed further in the following section, the OCC has decided to add an additional provision to the definition of covered bank to capture a national bank or FSA that has more than $700 billion in total assets as reported on its most recent Consolidated Reports of Condition and Income (Call Report).

A number of commenters urged the OCC to move to a financial consolidation standard to define a “subsidiary of a covered bank” instead of the BHC Act control standard set forth in the FRB Regulation YY.
31

These commenters asserted that, under U.S. generally accepted accounting principles (GAAP), a company generally would consolidate an entity in which it holds a majority voting interest, or over which it has the power to direct the most significant economic activities, to the extent it also holds a variable interest in the entity. In addition, commenters pointed out that financially consolidated subsidiaries are often subject to operational control and generally fully integrated into the parent's enterprise-wide governance, policies, procedures, control frameworks, business strategies, information technology systems, and management systems. These commenters pointed out that the concept of BHC Act control was designed to serve other policy purposes (
e.g.,
separation between banking and commercial activities). A number of commenters raised concerns that BHC Act control may include an entity that is not under the day-to-day operational control of the GSIB and over whom the GSIB does not have the practical ability to require remediation of that entity's QFCs to comply with the proposed rule. Moreover, commenters contended that entities that are not consolidated with a GSIB for financial reporting are unlikely to raise the types of concerns for the orderly resolution of GSIBs targeted by the proposed rule. Commenters also noted that the International Swaps and Derivatives Association (ISDA) master agreements and Universal Protocol define “affiliate” by reference to ownership of a majority of the voting power of an entity or person. For these reasons, commenters urged the OCC to define the term “subsidiary” of a covered bank based on financial consolidation under the final rule.

31
Commenters generally expressed a similar view with respect to the definition of “affiliate” of a covered bank as the term is used in §§ 47.4 and 47.5 of the proposed rule which was likewise defined by reference to BHC Act control.

Commenters generally urged that regardless of whether financial consolidation is adopted for the purpose of defining “subsidiary,” the final rule should exclude any entities over which the covered bank does not exercise operational control. Specifically, with respect to comments to the FRB Proposed Rule, commenters noted that such entities could include merchant banking portfolio companies, section 2(h)(2) companies, joint ventures, sponsored funds as distinct from their sponsors or investment advisors, securitization vehicles, entities in which the covered entity holds only a minority interest and does not exert a controlling influence, and subsidiaries held pursuant to provisions for debt previously contracted in good faith (DPC subsidiaries).
32

32

See, e.g.,
12 U.S.C. 1842(a)(A)(ii), 1843(c)(2); 12 CFR 225.12(b), 225.22(d)(1).

Similarly, OCC commenters also requested that covered banks should exempt entities over which a covered bank does not exercise operational control. The OCC notes that with respect to covered banks, such entities would include DPC subsidiaries,
33

as well as a covered bank's investment in community development corporations (CDCs) or small business investment corporations (SBICs).
34

These entities potentially present similar issues of operational control as in merchant banking, sponsored funds, and joint ventures.

33

See
12 U.S.C. 29; 12 CFR 5.34; and 12 U.S.C. 1464 (FSA DPC authority).

34
National banks may own or make controlling or minority investments in SBICs as defined under 13 CFR 107.50, CDCs pursuant to 12 U.S.C. 24(Eleventh), or other public welfare investments pursuant to 12 U.S.C. 24(Seventh). FSAs may also make such controlling or minority investments in SBICs and CDCs pursuant to their general lending authority under 12 U.S.C. 1464(c).

In terms of foreign GSIBs, some commenters believed that FBO subsidiaries for which the FBO has been given special relief by FRB order not to hold the subsidiary under an intermediate holding company (IHC) should not be included in the definition

of covered bank, even if such entities would be consolidated under financial consolidation principles.
35

These commenters asserted that since neither the covered bank nor the Foreign GSIB parent would provide credit support to these entities or name such entities in a cross-default provision in a QFC or related agreement, the failure of any of these types of entities would be unlikely to affect QFCs entered into by the covered bank or any other affiliate. These commenters further noted that the few such requests that have been granted by the FRB often involved situations in which the FBO did not have sufficient operational control over the entity to ensure its compliance. Commenters also requested that U.S. Federal branches and agencies of FBOs be excluded from the definition of “covered bank” where the FBO's home country legal framework imposes similar requirements of the final rule on the FBO and the Federal branch or agency. These commenters asserted that the requirements of the final rule would be duplicative of the requirements with respect to such Federal branches and agencies if their QFCs are already subject to existing and substantially equivalent resolution powers in the home country, without a proportionate incremental benefit to their resolvability or reduction in risk to U.S. financial stability.
36

35
FRB orders granting such approvals to FBOs that have requested such treatment can be found at Regulation YY Foreign Banking Organization Requests, available at
https://www.federalreserve.gov/supervisionreg/regulation-yy-foreign-banking-organization-requests.htm.

36
In the alternative, these commenters requested that the requirements only apply to U.S. Federal branches and agencies of Foreign GSIBs insofar as the home resolution regime and group resolution strategy would not adequately ensure that early termination rights, including cross-default rights against the U.S. IHC or subsidiaries, will not be triggered in resolution.

Final Rule.
Under the final rule, a “covered bank” is generally defined to include (1) a national bank or FSA not under a BHC and that has more than $700 billion in total assets as reported on their most recent Call Report, (2) a national bank or FSA that is a subsidiary of a global systemically important BHC that has been designated pursuant to subpart I of 12 CFR part 252 of this title (FRB Regulation YY); or (3) is a national bank or FSA subsidiary, or Federal branch or agency of a global systemically important FBO designated pursuant to subpart I of 12 CFR part 252 of this title (FRB Regulation YY) that has been designated pursuant to FRB Regulation YY.

The final rule generally adopts the definition of covered bank as proposed with the exception of the addition of a provision to include a national bank or FSA not under a BHC and that has more than $700 billion in total assets as reported on their most recent Call Report. This provision is intended to address the OCC's concern that a national bank or FSA, not under a BHC, with a sufficient number of large total assets would be subject to the requirement of the final rule. While currently a null set, the OCC believes that any national bank or FSA that has total assets that exceed $700 billion would raise similar concerns with respect to interconnectedness and financial contagion.

As in the proposed rule, a covered bank includes the OCC-regulated subsidiaries of entities identified as U.S. GSIB top-tier holding companies under the FRB GSIB surcharge rule.
37

U.S. GSIBs generally enter into QFCs through subsidiary legal entities rather than through the top-tier holding company.
38

Therefore, in order to increase GSIB resilience and resolvability by addressing the potential obstacles to orderly resolution posed by QFCs, it is necessary to apply the proposed restrictions to the U.S. GSIBs' subsidiaries. In particular, to facilitate the resolution of a GSIB under an SPOE strategy, in which only the top-tier holding company would enter a resolution proceeding while its subsidiaries would continue to meet their financial obligations, or an MPOE strategy where an affiliate of an entity that is otherwise performing under a QFC enters resolution, it is necessary to ensure that those subsidiaries or affiliates do not enter into QFCs that contain cross-default rights that the counterparty could exercise based on the holding company's or an affiliate's entry into resolution (or that any such cross-default rights are stayed when the holding company enters resolution). Moreover, including U.S. and non-U.S. entities of a U.S. GSIB as a covered bank should help ensure that such cross-default rights do not affect the ability of performing and solvent entities of a GSIB—regardless of jurisdiction—to remain outside of resolution proceedings.

37
12 CFR 217.402; 80 FR 49106 (Aug. 14, 2015).
See
the FRB final rule § 252.82(a)(1).

38
Under the clean holding company component of the FRB's recent Total Loss-Absorbing Capacity (TLAC) final rule, the top-tier holding companies of U.S. GSIBs would be prohibited from entering into direct QFCs with third parties.
See
82 FR 8266, 8298 (December 15, 2016).

The term “subsidiary” in the final rule continues to be defined by reference to BHC Act control as does the definition of “affiliate.”
39

The final rule does not define covered banks to include only those subsidiaries of GSIBs that are financially consolidated subsidiaries as requested by certain commenters. Defining “subsidiary” and “affiliate” by reference to BHC Act control is consistent with the definitions of those terms in the FDI Act and Title II of the Dodd-Frank Act. Specifically, Title II permits the FDIC, as receiver of a covered financial company or a receiver for its subsidiary, to enforce QFCs and other contracts of subsidiaries and affiliates, defined by reference to the BHC Act, notwithstanding cross-default rights based solely on the insolvency, financial condition, or receivership of the covered financial company.
40

Therefore, maintaining consistent definitions of subsidiary and affiliate with Title II should better ensure that QFC stays may be effected in a resolution under a U.S. Special Resolution Regime. As covered banks, as well as their subsidiaries and affiliates, are typically subsidiaries of BHCs, which are in turn subject to the activity restrictions and other requirements of the BHC Act, they should already know all of their BHC Act controlled subsidiaries and be familiar with BHC Act control principles.
41

Moreover, GSIBs should be able to rely on governance rights and other negotiated mechanisms to ensure that such subsidiaries conform their QFCs to the final rule's requirements.

39

See
12 CFR 252.2.

40
12 U.S.C. 5390(c)(16).

41
For example, under the FRB final rule a covered entity may own more than five percent (and less than 25 percent) of the voting shares of a registered investment company for which the covered entity provides investment advisory, administrative, and other services and has a number of director and officer interlocks, without controlling the fund for purposes of the BHC Act.
See
letter to H. Rodgin Cohen, Esq., Sullivan & Cromwell (First Union Corp.), from Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve System (June 24, 1999) (finding that a bank holding company does not control a mutual fund for which it provides investment advisory and other services and that complies with the limitations of section 4(c)(7) of the BHC Act (12 U.S.C. 1843(c)(7)), so long as (i) the BHC reduces its interest in the fund to less than 25 percent of the fund's voting shares after a six-month period, and (ii) a majority of the fund's directors are independent of the BHC and the BHC cannot select a majority of the board); see also 12 CFR 225.86(b)(3) (authorizing a financial holding company to organize, sponsor, and manage a mutual fund so long as (i) the fund does not exercise managerial control over the entities in which the fund invests, and (ii) the financial holding company reduces its ownership in the fund, if any, to less than 25 percent of the equity of the fund within one year of sponsoring the fund or such additional period as the FRB permits).

The final rule excludes from the scope of covered bank DPC subsidiaries, portfolio companies held under the

Small Business Investment Act of 1956, and certain companies engaged in the business of making public welfare investments. In general, there are legal restrictions and other limitations on the involvement of the GSIB in the operations of these kinds of subsidiaries. Moreover, it is unlikely that the disorderly unwind of the QFCs of these subsidiaries would impair the orderly resolution of the GSIB. Therefore, the impact of these exclusions should be relatively small while responding to commenter's concerns and reducing burden.

Finally, covered banks include almost all U.S. operations of Foreign GSIBs—their national banks, Federal savings associations, Federal branches, Federal agencies, or subsidiaries of such entities. The final rule, like the proposed rule, covers only the U.S. operations of Foreign GSIBs. To provide the same treatment for foreign GSIBs and U.S. GSIBs, the final rule also excludes DPC subsidiaries, portfolio companies held under the Small Business Investment Act of 1956, and public welfare investments of foreign GSIBs.
42

42

See
final rule § 47.3(b)(3)(ii)-(iv).

The final rule does not exempt U.S. Federal branches and agencies of Foreign GSIBs or U.S. subsidiaries of Foreign GSIBs that are not held under an IHC pursuant to a FRB order, as requested by certain commenters. As with the coverage of subsidiaries of U.S. GSIBs, coverage of the U.S. operations of foreign GSIBs will enhance the prospects for an orderly resolution of the Foreign GSIB and its U.S. operations. In particular, covering QFCs that involve any U.S. subsidiary or Federal branch or agency of a Foreign GSIB will reduce the potentially disruptive cancellation of those QFCs if the Foreign GSIB or any of its subsidiaries enters resolution, including resolution under the U.S. Bankruptcy Code or the U.S. Special Resolution Regimes.
43

43
The laws and regulations imposed in non-U.S. jurisdictions that commenters noted were similar to the requirements of the proposed rule do not address resolution under U.S. insolvency or the U.S. Special Resolution Regimes.

C. Covered QFCs (Sections 47.4(a), 47.5(a), 47.7, and 47.8)

1. General Definition

Proposal.
The proposed rule required covered banks to ensure that each “covered QFC” conforms to the requirements of sections 47.4 and 47.5. These sections required that a covered QFC (1) contain contractual stay-and-transfer provisions similar to those imposed under Title II of the Dodd-Frank Act and the FDI Act, and (2) limit the exercise of default rights based on the insolvency of an affiliate of the covered bank. A “covered QFC” was generally defined as any QFC that a covered bank enters, executes, or otherwise becomes party to. A party to a QFC included a party acting as agent under the QFC. “Qualified financial contract” or “QFC” was defined to have the same meaning as in Section 210(c)(8)(D) of Title II of the Dodd-Frank Act and would include derivatives, swaps, repurchase, reverse repurchase, and securities lending and borrowing transactions.
44

44
81 FR 55381, 55399 (August 19, 2016); 12 U.S.C. 5390(c)(8)(D).

Comments.
The application of the proposed rule's requirements to a “covered QFC” was one of the most commented upon aspects of the proposed rule. Certain commenters argued that the definition of QFC in Title II of the Dodd-Frank Act was overly broad and imprecise and could include agreements that market participants may not expect to be subject to the stay-and-transfer provisions of the U.S. Special Resolution Regimes. More generally, commenters argued that the proposed definition of QFC was too broad and would capture contracts that do not present any obstacles to an orderly resolution. Commenters urged the OCC to exclude a variety of types of QFCs from the requirements of the final rule. In particular, a number of commenters urged the OCC to exclude QFCs that do not contain any transfer restrictions or default rights, because these types of QFCs do not give rise to the risk that counterparties will exercise their contractual rights in a manner that is inconsistent with the provisions of the U.S. Special Resolution Regimes.

Commenters named several examples of contracts that fall into this category, including cash market securities transactions, certain spot foreign exchange (FX) transactions (including securities conversion transactions), retail brokerage agreements, retirement/Individual Retirement Account (IRA) account agreements, margin agreements, options agreements, FX forward master agreements, and delivery versus payment client agreements. Commenters contended that these types of QFCs number in the millions at some firms and that remediating these contracts to include the express provisions required by the final rule would require an enormous client outreach effort that would be extremely burdensome and costly while providing no meaningful resolution benefits. For example, commenters pointed out that for certain types of transactions, such as cash securities transactions, FX spot transactions, and retail QFCs, such a requirement could require an overhaul of existing market practice and documentation that affects hundreds of thousands, if not millions, of transactions occurring on a daily basis and significant education of the general market.

Commenters also urged the OCC to exclude QFCs that do not contain any default or cross-default rights but that may contain transfer restrictions. Commenters contended that examples of these types of agreements included investment advisory account agreements with retail customers, which contain transfer restrictions as required by Section 205(a)(2) of the Investment Advisers Act of 1940, but no direct default or cross-default rights; underwriting agreements;
45

and client onboarding agreements. A few commenters provided prime brokerage or margin loan agreements as examples of transactions that generally do not have default or cross-default rights but may have transfer restrictions. Another commenter also requested the exclusion of securities market transactions that generally settle in the short term, do not impose ongoing or continuing obligations on either party after settlement, and do not typically include default rights.
46

In these cases, commenters contended that remediation of these agreements would be burdensome with no meaningful resolution benefits.

45
However, some commenters noted that underwriting, purchase, subscription, or placement agency agreements may contain rights that could be construed as direct default rights or cross-default rights.

46
In the alternative, the commenter requested that such securities market transactions be excluded to the extent they are cleared, processed, and settled through (or subject to the rules of) financial market utilities through expansion of the proposed exemption for transactions with central counterparties. This aspect of the comment is addressed in the subsequent section discussing requests for expansion of the proposed exemption for transactions with central counterparties.

Commenters also argued for the exclusion of a number of other types of contracts from the definition of covered QFC in the final rule. In particular, a number of commenters urged the OCC to exclude contracts issued in the capital markets or related to a capital market issuance, like warrants or a certificate representing a call option, typically on a security or a basket of securities. Although warrants issued in capital markets may contain direct default and cross-default rights as well

as transfer restrictions, commenters argued that remediation of outstanding warrant agreements would be difficult, if not impossible, since remediation would require the affirmative vote of a substantial number of separate voting groups of holders to amend the terms of the instruments and that obtaining such consent could be expensive due to “hold-out” premiums. Commenters also argued that since these instruments are traded in the markets, it is not possible for an issuer to ascertain whether a particular investor in such instruments has also entered into other QFCs with the dealer or any of its affiliates (or vice versa) for purposes of complying with the proposed mechanism for remediation of existing QFCs.

Commenters argued that issuers would be able to comply if the final rule's requirements applied only on a prospective basis with respect to new issuances, since new investors could be informed of the terms of the warrant at the time of purchase and no after-the-fact consent would be required, as is the case with existing outstanding warrants. Commenters expressed the view that prospective application of the final rule's requirements to warrants would allow time for firms to develop new warrant agreements and warrant certificates, to engage in client outreach efforts, and to make any appropriate public disclosures. Commenters suggested that the requirements of the final rule should only apply to such instruments issued after the effective date of the final rule and that the compliance period for such new issuances be extended to allow time to establish new issuance programs that comply with the final rule's requirements. Other examples of contracts in this category given by commenters include contracts with special purpose vehicles that are multi-issuance note platforms, which commenters urged would be difficult to remediate for similar reasons to warrants other than on a prospective basis.

Commenters also urged the exclusion of contracts for the purchase of commodities in the ordinary course of business (
e.g.,
utility and gas energy supply contracts) or physical delivery commodity contracts more broadly.
47

In general, commenters argued that exempting these contracts would not increase systemic risk but would help ensure the smooth operation of utilities and the physical commodities markets.
48

Commenters indicated that failure to make commodity deliveries on time can result in the accrual of damages and penalties beyond the accrual of interest (
e.g.,
demurrage and other fines in shipping) and that counterparties may not be able to obtain appropriate compensation for amendment of default rights due to the difficulty of pricing the risk associated with an operational failure due to the failure to deliver a commodity on time. Commenters also contended that agreements with power operators governed by regulatory tariffs would be difficult, if not impossible, to remediate.
49

47
For example, some commenters urged the exclusion of all contracts requiring physical delivery between commercial entities in the course of regulatory business such as (i) contracts subject to a Federal Energy Regulatory Commission-filed tariff; (ii) contracts that are traded in markets overseen by independent system operators or regional transmission operators; (iii) retail electric contracts; (iv) contracts for storage or transportation of commodities; (v) contracts for financial services with regulated financial entities (
e.g.,
brokerage agreements and futures account agreements); and (vi) public utility contracts.

48
One commenter also argued that utility and gas supply contracts are covered sufficiently in Section 366 of the U.S. Bankruptcy Code. This section of the U.S. Bankruptcy Code places restrictions on the ability of a utility to “alter, refuse, or discontinue service to, or discriminate against, the trustee or the debtor solely on the basis of the commencement of a case under [the U.S. Bankruptcy Code] or that a debt owed by the debtor to such utility for service rendered before the order for relief was not paid when due.” 11 U.S.C. 366. The purpose and effect of § 47.5 of the final rule and Section 366 of the U.S. Bankruptcy Code are different and therefore do not serve as substitutes. Section 366 of the U.S. Bankruptcy Code does not address cross-defaults or provide additional clarity regarding the application of the U.S. Special Resolution Regimes. Similarly, § 47.5 of the final rule does not prevent a covered entity from entering into a covered QFC that allows the counterparty to exercise default rights once a covered entity that is a direct party either enters bankruptcy or fails to pay or perform under the QFC.

49
One commenter also requested exclusion of overnight transactions, particularly overnight repurchase agreements, arguing that such transactions present little risk of creating negative liquidity effects and that an express exclusion for such transactions may increase the likelihood that such contracts would remain viable funding sources in times of liquidity stress. Although the final rule does not exempt overnight repo transactions, the final rule may have limited if any effect on such transactions. As described below, the final rule provides a number of exemptions that may apply to overnight repo and similar transactions. Moreover, the restrictions on default rights in § 47.5 of the final rule do not apply to any right under a contract that allows a party to terminate the contract on demand or at its option at a specified time, or from time to time, without the need to show cause.
See
final rule § 47.2 (defining “default right”). Therefore, § 47.5 does not restrict the ability of QFCs, including overnight repos, to terminate at the end of the term of the contract.

Final Rule.
The final rule applies to any “covered QFC,” which generally is defined as any “in-scope QFC” that a covered entity enters into, executes, or to which the covered entity otherwise becomes a party.
50

As under the proposed rule, “qualified financial contract” or “QFC” is defined in the final rule as in Section 210(c)(8)(D) of Title II of the Dodd-Frank Act and includes swaps, repo and reverse repo transactions, securities lending and borrowing transactions, commodity contracts, and forward agreements.
51

Parties that enter into contracts with covered entities have been potentially subject to the stay-and-transfer provisions of Title II of the Dodd-Frank Act since its enactment. Consistent with Title II, the final rule does not exempt QFCs involving physical commodities. However, as explained below, the final rule responds to concerns regarding the smooth operation of physical commodities end users and markets by allowing counterparties to terminate QFCs based on the failure to pay or perform.

50

See
final rule § 47.3(c).

51

See
final rule § 47.2.
See also
12 U.S.C. 5390(c)(8)(D).

In response to concerns raised by commenters, the final rule exempts QFCs that have no transfer restrictions or default rights, as these QFCs have no provisions that the rule is intended to address. The final rule effects this exemption by limiting the scope of QFCs potentially subject to the rule to those QFCs that explicitly restrict the transfer of a QFC from a covered bank or explicitly provide default rights that may be exercised against a covered bank (in-scope QFCs).
52

This change addresses a major concern raised by commenters regarding the overbreadth of the definition of “covered QFC” in the proposed rule. The change also mitigates the burden of complying with the proposed rule without undermining its purpose by not requiring covered banks to conform contracts that do not contain the types of default rights and transfer restrictions that the final rule is intended to address. The OCC has declined, however, to exclude QFCs that have transfer restrictions (but no default rights or cross-default rights), as requested by certain commenters, as such QFCs would have provisions (
i.e.,
transfer restrictions) that are subject to the requirements of the final rule and could otherwise impede the orderly resolution of a covered entity or its affiliate.

52

See
final rule § 47.3(d).

The final rule provides that a covered bank is not required to conform certain investment advisory contracts described by commenters (
i.e.,
investment advisory contracts with retail advisory customers
53

of the covered bank that

only contain the transfer restrictions required by Section 205(a) of the Investment Advisers Act). The final rule also exempts existing warrants evidencing a right to subscribe or to otherwise acquire a security of a covered bank or its affiliate.
54

The final rule excludes these types of agreements since there is persuasive evidence that these types of contracts would be burdensome to conform and that it is unlikely that excluding such contracts from the requirements of the final rule would impair the orderly resolution of a GSIB.
55

53

See
final rule § 47.8(c)(1). The final rule defines retail customer or counterparty by reference to the Board's Regulation WW.
See
12 CFR 249.3;
see also
FR 2052a,

https://www.federalreserve.gov/

reportforms/forms/FR_2052a20161231_f.pdf.

Covered entities should be familiar with this definition and its application.

54

See
final rule § 47.8(c)(2). Warrants issued after the effective date of the final rule are not excluded from the requirements of the final rule.

55
These exemptions are not interpretations of the definition of QFC.

The final rule also provides the OCC with authority to exempt one or more covered banks from conforming certain contracts or types of contracts to the final rule after considering, in addition to any other factor the OCC deems relevant, the burden the exemption would relieve and the potential impact of the exemption on the resolvability of the covered bank or its affiliates.
56

Covered banks that request that the OCC exempt additional contracts from the final rule should be prepared to provide information in support of their requests. The OCC expects to consult as appropriate with the FRB and FDIC during its consideration of any such request.

56

See
final rule § 47.8(d).

2. Definition of Counterparty

Proposal.
As noted above, the proposed rule applied to any “covered QFC,” generally defined as a QFC that a covered entity enters after the effective date and a QFC entered earlier, but only if the covered entity or its affiliate enters a new QFC with the same person or an affiliate of the same person.
57

“Affiliate” in the proposed rule was defined in the same manner as under the BHC Act to mean any company that controls, is controlled by, or is under common control with another company.
58

As noted above, “control” under the BHC Act means the power to vote 25 percent or more of any class of voting securities; control in any manner the election of a majority of the directors or trustees; or exercise of a controlling influence over the management or policies.
59

57

See
proposed rule § 47.4(a). For convenience, this preamble generally refers to “a covered entity's QFCs” or “QFCs to which a covered entity is party” as shorthand to encompass this definition. [EDIT]

58

See
12 CFR 252.2 (defining “affiliate”).

59

See
12 U.S.C. 1841(k).

Comments.
Commenters argued that requiring remediation by a covered bank of an existing QFC if any entity in the GSIB group entered into a new QFC with an affiliate of the counterparty would make compliance with the proposed rule overly burdensome.
60

Commenters pointed out that this requirement would demand that the GSIB and the covered bank track each counterparty's organizational structure by relying on information provided by counterparties, which would subject counterparties to enhanced tracking and reporting burdens. Commenters requested that the phrase “or affiliate of the same person” be deleted from the definition of covered QFC and argued that such a modification would not undermine the ultimate goals of the rule since existing QFCs with the counterparty's affiliate would still have to be remediated if the covered entity or its affiliate entered into a new QFC with that counterparty affiliate. In the alternative, commenters argued that an affiliate of a counterparty be established by reference to financial consolidation principles rather than BHC Act control, since counterparties may not be familiar with BHC Act control. Commenters argued that many counterparties are not regulated BHCs and would be unfamiliar with BHC Act control. Some commenters also argued that a new QFC with one fund in a fund family should not result in other funds in the fund family being required to conform their pre-existing QFCs with the covered bank or an affiliate.

60
One commenter believed that the burden of conforming contracts with all affiliates of a counterparty would be too great, whether defined in terms of BHC Act control or financial consolidation principles, even though the burden would be reduced by definition in terms of financial consolidation principles.

Final Rule.
The final rule's definition of “covered QFC” has been substantially modified to address the concerns raised by commenters with respect to the remediation of existing QFCs. In particular, the final rule provides that a covered QFC includes a QFC that the covered bank entered, executed, or otherwise became a party to before January 1, 2019, if the covered bank or any affiliate that is a covered entity (under the FRB final rule), covered bank, or covered FSI (under the FDIC final rule) also enters, executes, or otherwise becomes a party to a QFC with the same person or a consolidated affiliate of the same person on or after January 1, 2019.
61

61

See
final rule § 47.3(c).

With respect to counterparties, the final rule has been changed to define “consolidated affiliate” by reference to financial consolidation principles, as generally reflected by U.S. GAAP or International Financial Reporting Standards (IFRS)
62

instead of by reference to the BHC Act. As commenters pointed out, counterparties will already track and monitor financially consolidated affiliates under either U.S. GAAP or IFRS. Moreover, exposures to a non-consolidated affiliate may be captured as a separate counterparty (
e.g.,
when the non-consolidated affiliate enters a new QFC with the covered bank or an affiliate of the covered bank that is either a covered bank, covered entity under FRB final rule, or a covered FSI under the FDIC final rule). As a consequence, modifying the coverage of affiliates in this manner addresses concerns raised by commenters regarding burden while still providing sufficient incentives to remediate existing covered QFCs.

62

See
final rule § 47.2.

As discussed, the definition of “covered QFC” is intended to limit the restrictions of the final rule to those financial transactions whose disorderly unwind has substantial potential to frustrate the orderly resolution of a GSIB. By adopting the Dodd-Frank Act's definition of QFC, with the modifications described above, the final rule generally extends stay-and-transfer protections to the same types of transactions as Title II of the Dodd-Frank Act. In this way, the final rule enhances the prospects for an orderly resolution in bankruptcy and under the U.S. Special Resolution Regimes.

3. Exclusion of Cleared QFCs and Financial Market Utilities

Proposal.
The proposed rule excluded from the definition of “covered QFC” all QFCs that are cleared through a central counterparty (CCP). The proposed rule, however, did not exclude from the definition of “covered QFC” QFCs that are cleared, processed, or settled through the facilities of a financial market utility (FMU). The proposed rule noted that the OCC was continuing to consider the appropriate treatment of centrally cleared QFCs, in light of differences between cleared and uncleared QFCs with respect to contractual arrangements, counterparty credit risk, default management, and supervision.

Comments.
Commenters generally expressed support for the exclusion of QFCs that are cleared through a CCP, but some commenters requested that the OCC broaden this exclusion in the final rule. In particular, a number of commenters urged the OCC to exclude the “client-facing leg” of a cleared swap

where a clearing member faces a CCP on one leg of the transaction and faces the client on an otherwise identical offsetting transaction.
63

One commenter requested the OCC confirm its understanding that “FCM agreements,” which the commenter defined as futures and cleared swaps agreements with a futures commission merchant (FCM), are excluded because FCM agreements “are only QFCs to the extent that they relate to futures and swaps and, since futures and cleared swaps are excluded, the FCM [a]greements are also excluded.”
64

The commenter requested, in the alternative, that the final rule expressly exclude such agreements.

63
Commenters argued that, in the European-style principal-to-principal clearing model, the clearing member faces the CCP on one swap (the “CCP-facing leg”), and the clearing member, frequently a covered bank or covered entity (under the FRB Proposed Rule), faces the client on an otherwise identical, offsetting swap (the “client-facing leg”). Under the proposed rule, only the CCP-facing leg of the transaction was excluded, even though the client-facing leg is necessary to the mechanics of clearing and is only entered into by the clearing member to effectuate the cleared transaction. Commenters argued that the proposed rule thus treated two pieces of the same transaction differently, which could result in an imbalance in insolvency or resolution and that the possibility of such an imbalance for the clearing member could expose the clearing member to unnecessary and undesired market risk. Commenters urged the OCC to adopt the same approach taken under § 2 of the Universal Protocol, which allows the client-facing leg of the cleared swap with the clearing member that is a covered bank or covered entity to be closed out substantially contemporaneously with the CCP-facing leg in the event the CCP were to take action to close out the CCP-facing leg.

Some commenters requested clarification that transactions between a covered bank or covered entity client and its clearing member (as opposed to transactions where the covered bank or covered entity is the clearing member) would be subject to the rule's requirements, since this would be consistent with the Universal Protocol. As explained in this section, the exemption in the final rule regarding CCPs does not depend on whether the covered bank or covered entity is a clearing member or a client. A covered QFC—generally a QFC to which a covered bank or covered entity is a party—is exempted from the requirements of the final rule if a CCP is also a party.

64
Letter to Legislative and Regulatory Affairs Division, Office of the Comptroller of the Currency, from James M. Cain, Sutherland Asbill & Brennan LLP, writing on behalf of the eleven Federal Home Loan Banks, at 2-3 (October 18, 2016).

A few commenters requested that the OCC modify the definition of “central counterparty,” which was defined by reference to the FRB Regulation YY
65

to mean “a counterparty (for example, a clearing house) that facilitates trades between counterparties in one or more financial markets by either guaranteeing trades or novating trades” in the proposed rule.
66

These commenters argued that a CCP does far more than “facilitate” or “guarantee” trades and that a CCP “interposes itself between counterparties to contacts traded in one or more financial markets, becoming the buyer to every seller and the seller to every buyer and thereby ensuring the performance of open contracts.”
67

As an alternative definition of CCP, these commenters suggested the final rule should define CCP to mean: “an entity (for example, a clearinghouse or similar facility, system, or organization) that, with respect to an agreement, contract, or transaction: (i) Enables each party to the agreement contract, or transaction to substitute, through novation or otherwise, the credit of the CCP for the credit of the parties; and (ii) arranges or provides, on a multilateral basis, for the settlement or netting of obligations resulting from such agreements, contracts, or transactions executed by participants in the CCP.”
68

65
In order to minimize the number of cross references in the definition section, where feasible, the rule replaces cross references with the actual text of the definition.

66
12 CFR 217.2.

67
Letter to Legislative and Regulatory Activities Division, Office of the Comptroller of the Currency, from Walt L. Lukken, President and CEO, Futures Industry Association, at 8 (October 17, 2016) (citing Principles of Financial Market Infrastructures (April 2012), published by the Committee on Payment and Settlement Systems and the International Organization of Securities Commissions, at 9).

68

Id.
at 9.

Commenters also urged the OCC to exclude from the requirements of the final rule all QFCs that are cleared, processed, or settled through the facilities of an FMU, as defined in Section 803(6) of the Dodd-Frank Act,
69

or that are entered into subject to the rules of an FMU.
70

For example, commenters argued that QFCs with FMUs, such as the provision of an extension of credit by a central securities depository (CSD) to a covered bank that is a member of the CSD in connection with the settlement of securities transactions, should be excluded from the requirements of the final rule. Commenters contended that, similar to CCPs, the relationship between a covered entity and FMU is governed by the rules of the FMU and that there are no market alternatives to continuing to transact with FMUs. Commenters argued that FMUs generally should be excluded for the same reasons as CCPs and that a broader exemption to cover FMUs would serve to mitigate the systemic risk of a GSIB in distress, an underlying objective of the rule's requirements. Commenters contended that such an exclusion would be consistent with the treatment of FMUs under regulation adopted by the United Kingdom (U.K.) and Germany. Some commenters also requested that related or underlying agreements to CCP-cleared QFCs and QFCs entered into with other FMUs also be excluded, since such agreements “form an integrated whole with [those] QFCs” and such an exemption would facilitate the continued expansion of the clearing and settlement framework and the benefits of such a framework.
71

One commenter urged that the final rule should not in any manner restrict an FMU's ability to close out a defaulting clearing member's portfolio, including potential liquidation of cleared contracts.

69
12 U.S.C. 5462(6). In general, Title VIII of the Dodd-Frank Act defines “financial market utility” to mean any person that manages or operates a multilateral system for the purpose of transferring, clearing, or settling payments, securities, or other financial transactions among financial institutions or between financial institutions and the person.
Id.

70
As discussed, one commenter who recommended an exclusion of securities market transactions that generally settle in the short term, do not impose ongoing or continuing obligations on either party after settlement, and do not typically include the default rights targeted by the proposed rule, requested this treatment in the alternative.

71
Letter to Legislative and Regulatory Affairs Division, Office of the Comptroller of the Currency, from Larry E. Thompson, Vice Chairman and General Counsel, The Depository Trust & Clearing Corporation, at 2 (October 17, 2016); Letter to Robert deV. Frierson, Secretary, Board of Governors of the Federal Reserve System, from Larry E. Thompson, Vice Chairman and General Counsel, The Depository Trust & Clearing Corporation, at 6 (August 5, 2016).

Final Rule.
The issues that the final rule is intended to address with respect to non-cleared QFCs may also exist in the context of centrally cleared QFCs. However, clearing through a CCP provides unique benefits to the financial system while presenting unique issues related to the cancellation of cleared contracts. Accordingly, the OCC continues to believe it is appropriate to exclude centrally cleared QFCs, in light of differences between cleared and non-cleared QFCs with respect to contractual arrangements, counterparty credit risk, default management, and supervision. The OCC has not extended the exclusion for CCPs to the client-facing leg of a cleared transaction because bilateral trades between a GSIB and a non-CCP counterparty are the types of transactions that the final rule intends to address and because nothing in the final rule would prohibit a covered entity clearing member and a client from agreeing to terminate or novate a trade to balance the clearing member's exposure. The final rule continues to define central counterparty as a counterparty that facilitates trades between counterparties in one or more financial markets by either guaranteeing trades or novating contracts, which is a broad definition used in the regulatory

capital rules
72

that should be familiar to market participants.

72

See
final rule § 47.2. The proposed rule defined CCP by cross reference to the definition in the FRB Proposed Rule, which in turn cross referenced the definition in the FRB Regulation Q (Capital Adequacy Regulations). The definition in Regulation Q (12 CFR 217.2) is the common definition of CCP also used in the OCC capital adequacy rule (12 CFR 3.2). For ease of reference, the final rule replaces these cross references with the text of the definition of CCP used in 12 CFR 3.2 and 217.2.

The final rule also makes clear that, if one or more FMUs are the only counterparties to a covered QFC, the covered bank is not required to conform the covered QFC to the final rule.
73

Therefore, an FMU's default rights and transfer restrictions under the covered QFC are not affected by the final rule. However, this exclusion would not include a covered QFC with a non-FMU counterparty, even if the QFC is settled by an FMU or if the FMU is a party to such QFC, because the final rule is intended to address default rights of non-FMU parties. For example, if two covered banks engage in a bilateral QFC that is facilitated by an FMU, and in the course of this facilitation each covered entity maintains a QFC solely with the FMU, then the final rule would not apply to each QFC between the FMU and each covered bank but the requirements of the final rule would apply to the bilateral QFC between the two covered banks. This approach ensures that QFCs that are directly with FMUs are treated in a manner similar to transactions between covered entities and CCPs, but also ensures that QFCs conducted by covered banks that are related to the direct QFC with the FMU remain subject to the final rule's requirements.

73

See
final rule § 47.8(a)(2). In response to commenters, the final rule uses the definition of FMU in Title VIII of the Dodd-Frank Act and may apply, for purposes of the final rule, to entities regardless of jurisdiction. The definition of FMU in the final rule includes a broader set of entities, in addition to CCPs. However, the definition in the final rule does not include depository institutions that are engaged in carrying out banking-related activities, including providing custodial services for tri-party repurchase agreements. The definition also explicitly excludes certain types of entities (
e.g.,
registered futures associations, swap data repositories) and other types of entities that perform certain functions for or related to FMUs (
e.g.,
FCMs).

The final rule does not explicitly exclude futures and cleared swaps agreements with a FCM, as requested by a commenter. The nature and scope of the requested exclusion is unclear, and therefore, it is unclear whether the exclusion would be necessary, on the one hand, or overbroad, on the other hand. However, the final rule makes a number of other clarifications and exemptions that may help address the commenter's concern regarding FCM agreements.

4. Exclusion of Certain QFCs Under Foreign Bank Multi-Branch Master Agreements

Proposed Rule.
To avoid imposing unnecessary restrictions on QFCs that are not closely connected to the United States, the proposed rule excluded from the definition of “covered QFC” certain QFCs of Foreign GSIBs that lack a close connection to the Foreign GSIB's U.S. operations.
74

The proposed definition of “QFC” included master agreements that apply to QFCs.
75

Master agreements are contracts that contain general terms that the parties wish to apply to multiple transactions between them; having executed the master agreement, the parties can then include those terms in future contracts through reference to the master agreement. Moreover, the Dodd-Frank Act's definition of “qualified financial contract,” which was proposed, treats master agreements for QFCs together with all supplements to the master agreement (including underlying transactions) as a single QFC.
76

74

See
proposed rule § 47.8.

75

See
proposed rule § 47.2.

76
12 U.S.C. 5390(c)(8)(D)(viii);
see also
12 U.S.C. 1821(e)(8)(D)(vii); 109 H. Rpt. 31, Prt. 1 (April 8, 2005) (explaining that a “master agreement for one or more securities contracts, commodity contracts, forward contracts, repurchase agreements or swap agreements will be treated as a single QFC under the [FDI Act] or the [Federal Credit Union Act] (but only with respect to the underlying agreements are themselves QFCs)”).

Foreign GSIBs have master agreements that permit transactions to be entered into both at a Federal branch or agency of the Foreign GSIB and at a non-U.S. location of the Foreign GSIB (such as a foreign branch). Notwithstanding the proposed rule's general treatment of a master agreement and all QFCs thereunder as a single QFC, the proposed rule would have excluded QFCs under such a “multi-branch master agreement” that are not booked at a covered bank and for which no payment or delivery may be made at a covered bank.
77

Under the proposed rule, a multi-branch master agreement was a covered QFC with respect to QFC transactions that are booked at a covered bank or for which payment or delivery may be made at a covered bank.

77

See
proposed rule § 47.8. With respect to a Federal branch or agency of a Foreign GSIB, a multi-branch master agreement that is a covered QFC solely because the master agreement permits agreements or transactions that are QFCs to be entered into at one or more Federal branches or agencies of the Foreign GSIB was considered a covered QFC for purposes of the proposed rule only with respect to such agreements or transactions booked at such Federal branches and agencies or for which a payment or delivery may be made at such Federal branches or agencies.

Comments.
Commenters expressed support for this exclusion, but requested that the requirement exclude from the definition of covered QFC those transactions under master agreements where payments and deliveries may be made by or to the Federal branch or agency so long as the transactions or assets are not booked in the Federal branch or agency. These commenters argued that the ability to make payments or deliveries alone does not make a QFC sufficiently closely connected to the United States to raise the concerns about resolution that the proposed rule was intended to address. Commenters also argued that the requirement to include new contractual terms in a QFC where payment or delivery may occur in the United States would require Foreign GSIBs to amend many additional QFCs booked abroad, many of which must also be amended to comply with contractual stay requirements of the Foreign GSIBs' home country regulatory regimes. Commenters argued that amending such QFCs under multi-branch master agreements that are not booked in the United States would require some Foreign GSIBs to amend thousands of contracts at significant cost and would impose a disproportionate burden on Foreign GSIBs as compared to U.S. GSIBs. These commenters argued this would impose a significant burden on non-U.S. covered banks with no benefit to U.S. financial stability, as these QFCs would not be expected to be subject to a U.S. resolution regime.

One commenter also recommended that multi-branch master agreements be treated as a single QFC, rather than requiring the application of different requirements to different transactions thereunder, so as to align the proposed rule's requirements with current industry-standard documentation and to avoid additional implementation hurdles and costs. The commenter recommended that the entirety of a multi-branch master agreement and underlying transactions be a covered QFC if a new QFC with the counterparty or its consolidated affiliates is booked to the Federal branch or agency after the compliance date or if a new QFC is entered into with an affiliate of the Federal branch or agency that is also subject to the requirements.

Final Rule.
The final rule has been modified to address the concerns raised by commenters. In particular, the final rule is modified to provide that, with respect to a Federal branch or agency of a Foreign GSIB, a Foreign GSIB multi-branch master agreement that is a

covered QFC solely because the master agreement permits agreements or transactions that are QFCs to be entered into at one or more Federal branches or agencies of the Foreign GSIB will be considered a covered QFC for purposes of this final rule only with respect to such agreements or transactions booked at such Federal branches and agencies.
78

The final rule does not provide that such an agreement will be a covered QFC solely because payment or delivery may be made at such Federal branch or agency. These modifications will avoid imposing unnecessary restrictions on QFCs that are not closely connected to the United States and will mitigate burden and reduce costs on Foreign GSIBs without undermining the purpose of the final rule. The purpose of this exclusion is to help ensure that, where a Foreign GSIB has a multi-branch master agreement, the Foreign GSIB will only have to conform those QFCs entered into under the multi-branch master agreement that could have the most direct effect on the covered Federal branch or agency of the Foreign GSIB and that could therefore have the most direct effect on the resolution of the Foreign GSIB and the financial stability of the United States.

78

See
final rule § 47.7.

The final rule does not, as requested by one commenter, deem the entirety of a multi-branch master agreement to be a covered QFC if a new QFC with the counterparty (or its consolidated affiliate) is booked to the covered entity or its affiliate. Many commenters supported excluding transactions from multi-branch master netting agreements that are not closely connected to the United States. In contrast to the proposed rule and these comments, the modification requested by this commenter would require transactions that are not booked in the United States or otherwise connected to the United States to be conformed to the requirements of the final rule. The commenter's concerns regarding costs associated with potentially breaking netting sets may nonetheless be addressed through adherence to the Universal Protocol or the U.S. Protocol, which are discussed below.

5. QFCs With Central Banks and Sovereign Entities

Proposed Rule.
Section 47.7 of the proposed rule provided that a covered bank would not be required to conform covered QFCs to which a CCP was a party. However, central banks and sovereign entities are not included in the proposed rule's definition of CCP consistent with Title II of the Dodd-Frank Act and the FDI Act. Therefore, covered QFCs entered into with sovereign entities and central banks would be required to adhere to the conformance requirements of § 47.6 of the proposed rule.

Comments.
Commenters urged the OCC to exclude QFCs with central bank and sovereign counterparties from the final rule. Commenters argued that sovereign entities might not be willing to agree to limitations on their QFC default rights and noted that other countries' measures, such as those of the United Kingdom and Germany, consistent with their governing laws, exclude central banks and sovereign entities. Commenters contended that central banks and sovereign entities are sensitive to financial stability concerns and resolvability goals, thus reducing the concern that they would exercise default rights in a way that would undermine resolvability of a GSIB or financial stability. Commenters indicated it was unclear whether central banks or sovereign entities would be permitted under applicable statutes to enter into QFCs with limited default rights, but did not provide specific examples of such statutes.
79

Commenters further noted that these entities did not participate in the development of the Universal Protocol and that the Universal Protocol does not provide a viable mechanism for compliance with the final rule by these entities.

79
These commenters argued that, to the extent central banks and sovereign entities are unable or unwilling to agree to limitations on their QFC default rights, application of the proposed rule's requirements to QFCs with these entities creates a significant disincentive for these entities to enter into QFCs with covered banks, resulting in the loss of valuable counterparties in a way that will hinder market liquidity and covered entity risk management.

Final Rule.
The OCC continues to believe that covering QFCs with sovereign entities and central banks under the final rule is an important requirement and has not modified the final rule to address the requests made by commenters. Excluding QFCs with sovereign entities and central banks would be inconsistent with Title II of the Dodd-Frank Act and the FDI Act. Moreover, the mass termination of such QFCs has the potential to undermine the resolution of a GSIB and the financial stability of the United States. The final rule provides covered banks two years to conform covered QFCs with sovereign entities and central banks (as well as certain other counterparties, as discussed below). This additional time should provide covered banks sufficient time to develop separate conformance mechanisms for sovereign entities and central banks, if necessary.

D. Definition of “Default Right”

Proposed Rule.
As discussed previously, a party to a QFC generally has a number of rights that it can exercise if its counterparty defaults on the QFC by failing to meet certain contractual obligations. These rights are generally, but not always, contractual in nature. One common default right is a setoff right which is the right to reduce the total amount that the non-defaulting party must pay by the amount that its defaulting counterparty owes. A second common default right is the right to liquidate pledged collateral and use the proceeds to pay the defaulting party's net obligation to the non-defaulting party. Other common rights include the ability to suspend or delay the non-defaulting party's performance under the contract or to accelerate the obligations of the defaulting party.

Finally, the non-defaulting party typically has the right to terminate the QFC, meaning that the parties would not make payments that would have been required under the QFC in the future. The phrase “default right” in § 47.2 of the proposed rule was broadly defined to include these common rights as well as “any similar rights.” Additionally, the definition included all such rights regardless of source, including rights existing under contract, statute, or common law.

However, the proposed definition excluded two rights that are typically associated with the business-as-usual functioning of a QFC. First, same-day netting that occurs during the life of the QFC in order to reduce the number and amount of payments each party owes the other was excluded from the definition of “default right.”
80

Second, contractual margin requirements that arise solely from the change in the value of the collateral or the amount of an economic exposure were also excluded from the definition.
81

The effect of these exclusions was to leave such rights unaffected by the proposed rule. The exclusions were appropriate because the proposed rule is intended to improve resolvability by addressing default rights that could disrupt an orderly resolution, and not to interrupt the parties' business-as-usual dealings under a QFC.

80

See
Proposed Rule § 47.2.

81

See id.

However, certain QFCs are also commonly subject to rights that would increase the amount of collateral or margin that the defaulting party (or a guarantor) must provide upon an event

of default. The financial impact of such default rights on a covered bank could be similar to the impact of the liquidation and acceleration rights discussed previously. Therefore, the proposed definition of “default right” included such rights (with the exception discussed in the previous paragraph for margin requirements based solely on the value of collateral or the amount of an economic exposure).
82

82

See id.

Finally, contractual rights to terminate without the need to show cause, including rights to terminate on demand and rights to terminate at contractually specified intervals, were excluded from the definition of “default right” for purposes the proposed rule's restrictions on cross-default rights (§ 47.5 of the proposed rule).
83

This was consistent with the proposed rule's objective of restricting only default rights that are related, directly or indirectly, to the entry into resolution of an affiliate of the covered bank, while leaving other default rights unrestricted.

83

See
Proposed Rule §§ 47.2 and 47.5.

Comments.
Commenters expressed support for a number of aspects of the definition of default rights. For example, a number of commenters supported the proposed exclusion from the definition of “default right” of contractual rights to terminate without the need to show cause, noting that such rights exist for a variety of reasons and that reliance on these rights is unlikely to result in a fire sale of assets during a GSIB resolution. At least one commenter requested that this exclusion be expanded to include force majeure events. Commenters also expressed support for the exclusion for what commenters referred to as “business-as-usual” payments associated with a QFC. However, these commenters requested clarification that certain “business-as-usual” actions would not be included in the definition of default right, such as payment netting, posting and return of collateral, procedures for the substitution of collateral and modification to the terms of the QFC, and also requested clarification that the definition of “default right” would not include off-setting transactions to third parties by the non-defaulting counterparty. One commenter urged that, if the OCC's goal is to provide that a party cannot enforce a provision that requires more margin because of a credit downgrade but may demand more margin for market price changes, the rule should state so explicitly. Another commenter expressed concern that the definition of default right in the proposed rule would permit a defaulting covered bank to demand collateral from its QFC counterparty as margin due to a market price change, but would not allow the non-covered counterparty to demand collateral from the covered bank.

Final Rule.
The final rule retains the same definition of “default right” as that of the proposed rule.
84

The OCC believes that the definition of default right is sufficiently clear and that additional modifications are not needed to address the concerns raised by commenters. The final rule does not adopt a particular exclusion for force majeure events, as requested by certain commenters, as it is not clear—without reference to particular contractual provisions—what this term would encompass. Moreover, it should be clear that events typically considered to be captured by force majeure clauses (
e.g.,
natural disasters) would not be related, directly or indirectly, to the resolution of an affiliate.
85

84

See
final rule § 47.2.

85

See
final rule § 47.5(b).

“Business-as-usual” rights regarding changes in collateral or margin would not be included within the definition of default right to the extent that the right or operation of a contractual provision arises solely from either a change in the value of collateral or margin or a change in the amount of an economic exposure. In response to commenters' requests for clarification, this exception includes changes in margin due to changes in market price, but does not include changes due to counterparty credit risk (
e.g.,
credit rating downgrades). Therefore, the right of either party to a covered QFC to require margin due to changes in market price would be unaffected by the definition of default right. Moreover, default rights that arise before a covered bank or its affiliate enters resolution, and that would not be affected by the stay-and-transfer provisions of the U.S. Special Resolution Regimes also would not be affected.

With respect to transactions with third parties, the final rule, like the proposed rule, does not require covered banks to address default rights in QFCs solely between parties that are not covered banks (
e.g.,
off-setting transactions to third parties by the non-defaulting counterparty, to the extent none are covered banks).

E. Required Contractual Provisions Related to U.S. Special Resolution Regimes (§ 47.4)

Proposed Rule.
The proposed rule generally would have required a covered QFC to explicitly provide both (a) that the transfer of the QFC (and any interest or obligation in or under it and any property collateralizing it) from the covered bank to a transferee would be effective to the same extent as it would be under the U.S. Special Resolution Regimes if the covered QFC were governed by the laws of the United States or of a state of the United States and (b) that default rights with respect to the covered QFC that could be exercised against a covered bank could be exercised to no greater extent than they could be exercised under the U.S. Special Resolution Regimes if the covered QFC were governed by the laws of the United States or of a state of the United States.
86

The proposed rule would define the term “U.S. Special Resolution Regimes” to mean the FDI Act
87

and Title II of the Dodd-Frank Act,
88

along with regulations issued under those statutes.
89

86

See
Proposed Rule § 47.4.

87
12 U.S.C. 1811-1835a.

88
12 U.S.C. 5381-5394.

89

See
Proposed Rule § 47.2.

Comments.
A number of commenters noted that the wording of these requirements in proposed § 47.4 was confusing and could be read to be inconsistent with the intent of the section. In response to these comments, the final rule makes clearer that the substantive restrictions apply only in the event the covered bank (or, in the case of the requirement regarding default rights, its affiliate) becomes subject to a proceeding under a U.S. Special Resolution Regime.
90

90

See
id.

A number of commenters argued that QFCs should be exempt from the requirements of § 47.4 of the proposed rule if the QFC is governed by U.S. law. An example of such a QFC provided by commenters includes the standard form repurchase and securities lending agreement published by the Securities Industry and Financial Markets Association. These commenters argued that counterparties to such agreements are already required to observe the stay-and-transfer provisions of the FDI Act and Title II of the Dodd-Frank Act, as mandatory provisions of U.S. Federal law, and that requiring an amendment of these types of QFCs to include the express provisions required under § 47.4 would be redundant and would not provide any material resolution benefit, but would significantly increase the remediation burden on covered banks.

Other commenters suggested a three-prong test of “nexus with the United States” for purposes of recognizing an exclusion from the express acknowledgment of the requirements of § 47.4 of the proposed rule. In

particular, these commenters argued that the presence of two factors, in addition to the contract being governed by U.S. law, would provide greater certainty that courts would apply the stay-and-transfer provisions of the FDI Act and Title II of the Dodd-Frank Act: (1) If a contract is entered into between entities organized in the United States; and (2) to the extent the GSIB's obligations under the QFC are collateralized, if the collateral is held with a U.S. custodian or depository pursuant to an account agreement governed by U.S. law.
91

Other commenters contended that only whether the contract is under U.S. law, and not the location of the counterparty or the collateral, is relevant to the analysis of whether the FDI Act and the Dodd-Frank Act would govern the contract. Commenters also requested that if the first additional factor (
i.e.,
that the QFC be entered into between entities organized in the United States) were to be included within the exception, it should be broadened to include counterparties that have

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2017-25529. Public record. Not legal advice.