Fitch: US QFC Rule Raises Questions for Banks and Counterparties

NEW YORK--(BUSINESS WIRE)-- The Fed's proposed Qualified Financial Contract (QFC) rule may help facilitate orderly resolution in the event of the collapse of a large systemically important US bank, but raises questions for the bank counterparties that may be forced into QFCs with less favorable terms should the rule be implemented, says Fitch Ratings. There are also questions as to whether the terms of the QFC rule, such as the amount of time granted to stay the cancellation of the contracts, will be sufficient in the event of resolution.

The proposed rule, announced on May 3, would require the counterparties - usually asset managers - in QFCs with global systemically important banks (G-SIBs) to waive their rights to terminate the contracts and claim payments for up to 48 hours. The rule would force US G-SIB holding companies and the US operations of foreign G-SIBs to have all future QFCs, mostly derivatives and repo contracts, include stays on early termination and a prohibition on cross-default provisions.

The rule would essentially formalize many of the provisions of the International Swaps and Derivatives Association (ISDA) Universal Resolution Stay Protocol (URSP), which has been adopted by 213 banks and financial institutions globally. QFCs that adhere to the ISDA USRP and its annexes would be compliant with the rule and would not require additional compliance burden.

To address concerns that asset managers would not enter into these new contracts, the ISDA has also recently announced the new stand-alone Resolution Stay Jurisdictional Modular Protocol. The Jurisdictional Modular Protocol was designed to help counterparties comply with new stay regulations without "over complying" if they adhered to the URSP written before the stay regulations were announced in the US and, therefore, have some differing requirements from the Fed's proposed QFC rule. It remains unclear whether the Fed will deem the ISDA's Jurisdictional Modular Protocol as compliant with its proposal.

The rule is designed to enable regulators to work through a bank resolution and find alternate owners to take over the QFCs of a failing G-SIB within the 48-hour stay. This should help reduce the potential for a G-SIB failure resulting in the destabilization of other banks through a mass and sudden cancellation of QFCs. According to the Fed's proposal, existing QFCs would be subject to renegotiation to become compliant with the rule if an existing counterparty entered a new contract with a covered G-SIB, but the contracts would otherwise be grandfathered.

As such, counterparties not regulated by bank regulators could be potentially forced into contracts that are less favorable to them as a result of bank regulation. The widespread adoption of resolution-stay rules internationally, including through the ISDA protocols and existing regulation in many countries such as the UK, Germany and Switzerland, would limit the options for non-bank counterparties.

Beyond the counterparties, the new rule raises some other questions about the effects for the broader financial system. Cleared derivatives will be exempt from the rule, which could mean that some systemic risks may be moved from banks to clearinghouses as a result. Furthermore, it is unclear whether 48 hours will be sufficient time to work through all the QFCs of a G-SIB, especially if the resolution occurs during a period of systemic financial stress.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160516006026/en/

Fitch Ratings
Joo-Yung Lee, +1-212-908-0560
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Source: Fitch Ratings

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