If you’re a company that uses derivatives, repurchase agreements and certain other types of financial contracts in your business, you may have received a notice from the financial institutions with which you deal about the need to take action in connection with those contracts. You may have wondered why the financial institution sent you the notice, what you need to do, whether there are alternatives and, if there are options, the risks and benefits of taking certain actions compared to others. This alert, with the assistance of your Dentons contact, will enable you to respond in a way that both addresses the financial institution’s regulatory requirements and allows you to consider the burdens and benefits of the different ways that you address them.

Why did I receive the notice?

You were contacted by a financial institution because (1) you are party to a “qualified financial contract” (QFC) with that financial institution or its affiliate and (2) the financial institution is a “global systemically important bank” (GSIB), which means that it and its affiliates are subject to the QFC Stay Rules adopted by US banking regulators in late 2017.

What is a qualified financial contract?

The Dodd–Frank Wall Street Reform and Consumer Protection Act¹, commonly referred to as “Dodd-Frank” defines a QFC very broadly. The definition includes any securities contract, commodity contract, forward contract, repurchase agreement, swap agreement and any similar agreement that the Federal Deposit Insurance Corporation (FDIC) determines by regulation, resolution or order to be a qualified financial contract.² As a general matter, master agreements (such as those adopted by the International Swaps and Derivatives Association, or ISDA) that relate to QFCs are themselves QFCs. The QFCs that are the subject of the QFC Stay Rules discussed below are the ones that include certain provisions that US banking regulators have determined are or may be detrimental to the orderly resolution of a GSIB. These are referred to as “in-scope QFCs,” and they are the driving force behind your financial institution’s sending you the notice.

Why does it matter that my bank is a GSIB?

Following the financial crisis of 2008, a number of jurisdictions (including the United States) adopted laws and regulations that conferred upon financial regulators the power to assume control of failing or at-risk large financial institutions in lieu of a traditional resolution (bankruptcy) proceeding. This resulted in the creation of special resolution regimes around the world, each of which is designed to employ a more orderly resolution strategy for a failing or failed bank that has been deemed “too big to fail.”

These large banks (i.e., the GSIBs) to which these special resolution regime rules pertain are designated by the international Financial Stability Board from time to time based on data and assessment methodology designed by the Basel Committee on Banking Supervision³. Eight US banking institutions are currently designated as GSIBs.

Which institutions are subject to the QFC Stay Rules?

The QFC Stay Rules in effect in the United States⁴ cover not only US GSIBs and their worldwide subsidiaries but also the US branches, agencies and subsidiaries of non-US GSIBs These are commonly referred to as QFC “covered entities.”

What do the QFC Stay Rules require?

A QFC is considered to be an “in-scope QFC” and therefore subject to the QFC Stay Rules if it (1) contains an express restriction on the ability of a GSIB to transfer its rights under the QFC to another entity or (2) enables the counterparty to a “covered entity” to exercise rights against the covered entity in the event of the covered entity’s default under a QFC. US banking regulators view such provisions as potentially hampering their ability to effect an orderly resolution of a failing GSIB or its related covered entities, and thereby to mitigate systemic market risk in the aftermath of such a failure. Accordingly, the QFC Stay Rules require all GSIBs to obtain acknowledgements from you and their other QFC counterparties that you will stay (i.e., not exercise) your default rights and not enforce any transfer restrictions against the GSIB to the extent required by the QFC Stay Rules.

So what do I have to do?

The QFC Stay Rules provide that the acknowledgements described above can be obtained in a few ways. In the first place, they recognize compliance by adherence to the ISDA 2015 Universal Stay Protocol (including the Other Agreements Annex) or a “US protocol” as described in the QFC Stay Rules. Based on the requirements for a safe-harbored “US protocol,” the ISDA developed the ISDA US Stay Protocol. Both of these ISDA protocols can be accessed through at isda.org. There is a cost of US$500 for adherence to each such protocol, which, once a party has adhered, would apply to all QFCs between the party and all other adhering parties.

Alternatively, the parties to a QFC can comply with the QFC Stay Rules by entering into a bilateral amendment, which binds only those parties with respect to their own QFCs. To that end, the ISDA has prepared templates that entities subject to the QFC Stay Rules, as well as their counterparties (including you), can use to satisfy the QFC Stay Rules’ requirements for bilateral amendments. These forms are also available at isda.org. It is not possible to comply with the QFC Stay Rules by bilaterally incorporating the terms of the ISDA US Stay Protocol, unless all parties to an in-scope QFC have adhered to the ISDA Universal Stay Protocol and Other Agreements Annex.

Are there benefits or risks associated with protocol adherence versus bilateral amendment?

Different protections are afforded to counterparties of QFC covered entities based on whether the counterparty adheres to a protocol or enters into a bilateral amendment. For example, a counterparty to a bilateral amendment would have to agree to limitations on the exercise of default rights if an affiliate of the QFC covered entity entered into any type of insolvency proceeding, including a non-US one. In contrast, the ISDA US Stay Protocol provides for a limitation on the exercise of default rights only if such an affiliate enters into certain types of US insolvency proceedings. The list of differences between adherence via a protocol and bilateral compliance with the QFC Stay Rules is extensive. ISDA has published a comparison of creditor protections afforded by each methodology, which can be accessed here.

What is the deadline to adhere or enter into a bilateral amendment?

Required compliance with the QFC Stay Rules for in-scope QFCs depends on the parties to the QFC. If each party to the in-scope QFC is a QFC covered entity, then the compliance date is January 1, 2019. If each party to the in-scope QFC is a “financial counterparty” but is not a “small financial institution,”⁵ the compliance date is July 1, 2019. Finally, with respect to all other in-scope QFCs, the compliance date is January 1, 2020. Notwithstanding the foregoing deadlines, many financial institutions are asking their counterparties to comply well in advance of any applicable dates.

The QFC Stay Rules are complex. Your Dentons contact can help you in navigate these rules and determine the best way to comply with them.

1. Pub.L. 111–203, H.R. 4173.↩
2. 12 U.S.C. §1821(e)(8)(D). This statute further defines “securities contract,” “commodity contract,” “forward contract,” “repurchase agreement” and “swap agreement,” each of which covers a broad spectrum of financial instruments.↩
3. The 2018 list of GSIBs can be accessed via http://www.fsb.org/2018/11/2018-list-of-global-systemically-important-banks-g-sibs/.↩
4. 12 C.F.R. §§ 252.2, 252.81-88 (Board of Governors of the Federal Reserve System, 12 C.F.R. §§ 382.1-7 (Federal Deposit Insurance Corporation) and 12 C.F.R. §§ 47.1-8 (Office of the Comptroller of the Currency).↩
5. Both “financial counterparty” and “small financial institution” are defined in 12 C.F.R. §§ 252.2, 252.81-88.↩