The New QFC Stay Rules and How They Affect GSIBs

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In the aftermath of Lehman, the US banking agencies launched a number of regulations to account for the ripple effects that would ensue from a “too-big-to-fail” crisis — including new rules aimed at improving the resolvability of global systemically important banks by mitigating the risk of destabilizing closeouts in the event of such a collapse. A key element of these new regulations is the Qualified Financial Contract Resolution Stay Regulations (QFC Stay Rules), which require that GSIBs amend their QFCs to include certain terms intended to mitigate such destabilizing closeouts.

The QFC Stay Rules require GSIBs to impose certain restrictions on their counterparties’ termination rights and other default rights in the event of a GSIB’s insolvency, as well as restrict the transfer of such contracts. To this end, the rules require GSIBs to amend their QFCs to include provisions that, if triggered in the event of a GSIB’s bankruptcy, will render such transfer restrictions and default rights inoperative for a period of time up to 5:00 p.m. on the business day following commencement of a GSIB’s FDIC Receivership (or, in the case of an unsecured debt instrument, until the applicable statutory expiration date for the instrument).

There are currently two methods available for GSIBs to bring their QFCs into compliance with the QFC Stay Rules: bilateral amendment and ISDA protocol adherence. Bilateral amendment requires that a GSIB amend all its in-scope QFCs with each of its counterparties (and their consolidated affiliates), which may lead to a substantial increase in costs and imposes a risk to those non-GSIBs that the GSIB may terminate the agreement. Protocol adherence, on the other hand, is conducted on a corporate group basis and provides for a “one-stop shop” for amending all in-scope QFCs on a GSIB’s books with its adherent counterparties.

The most common method of complying with the QFC Stay Rules is through ISDA Protocol Adherence, either directly (in which case the 2018 protocol will apply) or by incorporation by reference (the 2015 protocol applies). Incorporating the ISDA protocols into a governing document will automatically amend all in-scope QFCs between that governing document and any adhering GSIB to incorporate the QFC Provisions. However, the ISDA protocols contain a number of dispensations from the resolution stay provisions in the QFC Stay Rules and, in some circumstances, may prove to be an overly broad solution for a particular set of circumstances.