The Federal Reserve Board on Friday adopted a final rule to enhance financial stability by requiring US global systemically important banking institutions (GSIBs) and the US operations of foreign GSIBs to amend qualified financial contracts to prevent their immediate cancellation or termination if the firm enters bankruptcy or a resolution process.
Qualified financial contracts (QFCs) include derivatives, securities lending, and short-term funding transactions such as repurchase agreements. Given the large volume of QFCs to which GSIBs are a party, the mass termination of QFCs in the event of financial distress or failure of a GSIB may lead to the disorderly failure of the firm, spark asset fire sales, and transmit financial distress across the US financial system.
The final rule contains two key requirements. First, the final rule requires QFCs of GSIBs, including those with foreign counterparties, to clarify that U.S. resolution laws providing for a temporary stay to prevent mass terminations apply to the contracts. Second, the final rule prohibits the QFCs of GSIBs from allowing the exercise of default rights that could spread the bankruptcy of one GSIB entity to its solvent affiliates.
“The final rule will reduce the threat that a disorderly unraveling of QFCs would pose to our financial system and the broader economy,” said Governor Jerome Powell.