Federal Register Vol. 82, No.228,

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

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).

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.

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).

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.

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.

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.

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

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.

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.11

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

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

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.

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.

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

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

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.

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

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

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

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.

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

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

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.

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).

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

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

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.

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

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.

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

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.

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.

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

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

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

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.

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

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.

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.

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

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.

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

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.

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

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.

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.

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.

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

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.

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.

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.

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.

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

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.

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.

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.

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.

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.

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.

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

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.

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

“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).

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

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

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 principal places of business or that are otherwise domiciled in the United States.

Commenters also argued that it would be more appropriate for Congress to act to obtain cross-border recognition of U.S. Special Resolution Regimes, rather than for the OCC to do so through this final rule.

Final Rule. The requirements of the final rule seek to provide certainty that all covered QFCs would be treated the same way in the context of a resolution of a covered bank under the Dodd-Frank Act or the FDI Act. The stay-and-transfer provisions of the U.S. Special Resolution Regimes should be enforced with respect to all contracts of any U.S. GSIB entity that enters resolution under a U.S. Special Resolution Regime, as well as all transactions of the subsidiaries of such an entity. Nonetheless, it is possible that a court in a foreign jurisdiction would decline to enforce those provisions. In general, the requirement that the effect of the statutory stay-and-transfer provisions be incorporated directly into the QFC contractually helps to ensure that a court in a foreign jurisdiction would enforce the effect of those provisions, regardless of whether the court would otherwise have decided to enforce the U.S. statutory provisions.92 Further, the knowledge that a court in a foreign jurisdiction would reject the purported exercise of default rights in violation of the required contractual provisions would deter counterparties of covered banks, covered entities (under the FRB final rule), or covered FSIs (under the FDIC final rule), from attempting to exercise such rights.

In response to comments, the final rule exempts from the requirements of § 47.4 a covered QFC that meets two requirements.93 First, the covered QFC must state that it is governed by the laws of the United States or a State of the United States.94 It has long been clear that the laws of the United States and the laws of a State of the United States both include U.S. Federal law, such as the U.S. Special Resolution Regimes.95 Therefore, this requirement ensures that contracts that meet this exemption also contain language that helps ensure that foreign courts will enforce the stay-and-transfer provisions of the U.S. Special Resolution Regimes. Second, the QFC counterparty to the covered bank must be organized under the laws of the United States or a State,96 have its principal place of business97 located in the United States, or be a Federal branch or agency.98 Similarly, a counterparty that is an individual must be domiciled in the United States.99 This requirement helps ensure that the FDIC will be able to quickly and easily enforce the stay-and-transfer provisions of the U.S. Special Resolution Regimes.100 This exemption is expected to significantly reduce the burden associated with complying with the final rule while continuing to provide assurance that the stay-and-transfer provisions of the U.S. Special Resolution Regimes may be enforced.

This section of the final rule is consistent with efforts by regulators in other jurisdictions to address similar risks by requiring that financial firms within their jurisdictions ensure that the effect of the similar provisions under these foreign jurisdictions' respective special resolution regimes would be enforced by courts in other jurisdictions, including the United States. For example, the U.K.'s Prudential Regulation Authority (PRA) recently required certain financial firms to ensure that their counterparties to newly created obligations agree to be subject to stays on early termination that are similar to those that would apply upon a U.K. firm's entry into resolution if the financial arrangements were governed by U.K. law.101 Similarly, the German parliament passed a law in November 2015 requiring German financial institutions to have provisions in financial contracts that are subject to the law of a country outside of the European Union that acknowledge the provisions regarding the temporary suspension of termination rights and accept the exercise of the powers regarding such temporary suspension under the German special resolution regime.102 Additionally, the Swiss Federal Council requires that banks “ensure at both the individual institution and group level that new agreements or amendments to existing agreements which are subject to foreign law or envisage a foreign jurisdiction are agreed only if the counterparty recognizes a postponement of the termination of agreements in accordance with” the Swiss special resolution regime.103 Japan's Financial Services Agency also revised its supervisory guidelines for major banks to require those banks to ensure that the effect of the statutory stay decision and statutory special creditor protections under Japanese resolution regimes extends to contracts governed by foreign laws.104

As discussed in Section III.A. of this preamble, the OCC believes it is appropriate to adopt this final rule in order to promote the safety and soundness of the Federal banking system, and as a consequence, U.S. financial stability, by improving the resolvability and resilience of national banks, FSAs, and Federal branches and agencies, pursuant to its existing statutory authorities. Because of the current risk that the stay-and-transfer provisions of U.S. Special Resolution Regimes may not be recognized under the laws of other jurisdictions, § 47.4 of the final rule requires similar contractual recognition to help ensure that courts in foreign jurisdictions will recognize these provisions.

This requirement advances the goal of the final rule of removing QFC-related obstacles to the orderly resolution of covered banks, and by extension their associated GSIBs. As discussed above, restrictions on the exercise of QFC default rights are an important prerequisite for an orderly GSIB resolution. Congress recognized the importance of such restrictions when it enacted the stay-and-transfer provisions of the U.S. Special Resolution Regimes. As demonstrated by the 2007-2009 financial crisis, the modern financial system is global in scope, and covered banks are party to large volumes of QFCs with connections to foreign jurisdictions. The stay-and-transfer provisions of the U.S. Special Resolution Regimes would not achieve their purpose of facilitating orderly resolution in the context of the failure of a GSIB with large volumes of QFCs, if such QFCs could escape the effect of those provisions. To remove doubt about the scope of coverage of these provisions, the requirements of § 47.4 of the final rule would ensure that the stay-and-transfer provisions apply as a matter of contract to all covered QFCs, wherever the transaction. This will advance the resolvability goals of the Dodd-Frank Act and the FDI Act and improve the resiliency of covered banks subject to the requirements.

Proposed Rule and Final Rule. Section 47.5 of the final rule, like the proposed rule, pertains to cross-default rights in QFCs between covered banks and their counterparties, many of which are subject to credit enhancements (such as guarantees) provided by an affiliate of the covered bank. Because credit enhancements on QFCs are themselves “qualified financial contracts” under the Dodd-Frank Act's definition of that term (which this final rule adopts), the final rule includes the following additional definitions in order to precisely describe the relationships to which this section applies. These definitions are the same as under the proposed rule since no comments were received on these definitions.

First, the final rule distinguishes between a credit enhancement and a “direct QFC,” which is defined as any QFC that is not a credit enhancement. The final rule also defines “direct party” to mean a covered bank that itself is a party to the direct QFC, as distinct from an entity that provides a credit enhancement. In addition, the final rule defines “affiliate credit enhancement” to mean “a credit enhancement that is provided by an affiliate of the party to the direct QFC that the credit enhancement supports,” as distinct from a credit enhancement provided by either the direct party itself or by an unaffiliated party. Moreover, the final rule defines “covered affiliate credit enhancement” to mean an affiliate credit enhancement provided by a covered bank, or a covered entity under the FRB final rule, and defines “covered affiliate support provider” to mean the affiliate of the covered bank that provides the covered affiliate credit enhancement. Finally, the final rule defines the term “supported party” to mean any party that is the beneficiary of the covered affiliate support provider's obligations under a covered affiliate credit enhancement (that is, the QFC counterparty of a direct party, assuming that the direct QFC is subject to a covered affiliate credit enhancement).

Proposed Rule. Subject to certain exceptions discussed below, the proposed rule generally prohibited a covered bank from being a party to a covered QFC that allows for the exercise of any default right that is related, directly or indirectly, to the entry into resolution of an affiliate of the covered bank. The proposed rule also generally prohibited a covered bank from being party to a covered QFC that would prohibit the transfer of any credit enhancement applicable to the QFC (such as another entity's guarantee of the covered bank's obligations under the QFC), along with associated obligations or collateral, upon the entry into resolution of an affiliate of the covered bank.105

Comments. One commenter expressed strong support for these provisions.106 Another commenter expressed support for this provision as currently limited in scope under the proposed rule to prohibited cross-default rights and requested that the scope not be expanded.

A number of commenters representing counterparties to covered banks objected to § 47.5 of the proposed rule and requested the elimination of this provision. These commenters expressed concern about limitations on counterparties' exercise of default rights during insolvency proceedings and argued that rights should not be taken away from contracting parties other than where limitation of such rights is necessary for public policy reasons and the resolution process is controlled by a regulatory authority with particular expertise in the resolution of the type of entity subject to the proceedings. Certain commenters argued that eliminating cross-default termination rights undermines the ability of QFC counterparties to effectively manage and mitigate their exposure to market and credit risk to a GSIB and interferes with market forces. One commenter similarly argued that, unless appropriate measures to strengthen the financial condition and creditworthiness of a failing GSIB during and after the temporary stay are taken, the stay will only expose QFC counterparties to an additional 48 hours of credit risk exposure without achieving the orderly resolution goals of the proposed rule.

Another commenter argued that non-defaulting counterparties should not be prevented from filing proofs of claim or other pleadings in a bankruptcy case during the stay period, since bankruptcy deadlines might pass and leave the counterparty unable to collect the unsecured creditor dividend. Commenters contended that restrictions on cross-default rights may lead to pro-cyclical behavior with asset managers moving funds away from covered entities as soon as those entities show signs of distress, and perhaps even in normal situations, and would disadvantage non-GSIB parties (e.g., end users who rarely receive initial margin from GSIB counterparties and are less well protected against a GSIB default).107

Some commenters argued that, if these rights must be restricted by law, Congress should impose such restrictions and that the requirements of the proposed rule circumvented the legislative process by creating a de facto amendment to the U.S. Bankruptcy Code that forecloses countless QFC counterparties from exercising their rights of cross-default protection under Section 362 of the U.S. Bankruptcy Code. Some of these commenters argued that parties cannot by contract alter the U.S. Bankruptcy Code's provisions, such as the administrative priority of a claim in bankruptcy, and one commenter suggested that non-covered bank counterparties may challenge the legality of contractual stays on the exercise of default rights if a GSIB becomes distressed. Certain commenters also questioned the OCC's ability to rely on its authority under the National Bank Act in imposing these requirements over QFC counterparties not subject to its supervision and argued that making Title II resolution possible under the U.S. Bankruptcy Code was not an appropriate justification for the proposed rule. Other commenters, however, argued that the provisions of the proposed rule were necessary to address systemic risks posed by the exemption for QFCs in the U.S. Bankruptcy Code.

As an alternative to eliminating the proposed rule's requirements to remediate cross-default rights, these commenters expressed the view that, if the OCC adopts the proposed rule as final, the final rule should at least contain those minimum creditor protections established by the Universal Protocol. Certain commenters also argued that this provision in the proposed rule was overly broad in that it covered not only U.S. Federal resolution and insolvency proceedings but also State and foreign resolution and insolvency proceedings.108 Certain commenters also urged the OCC to provide a limited exception to these restrictions, if retained in the final rule, to help ensure the continued functioning of physical commodities markets.109

Some commenters argued that the OCC should eliminate the stay on default rights that are related “indirectly” to an affiliate of the direct party becoming subject to insolvency proceedings, claiming it is unclear what constitutes a right related “indirectly” to insolvency and noting that any default right exercised by a counterparty after an affiliate of that counterparty enters resolution could arguably be motivated by the affiliate's entry into resolution.

Final Rule. The final rule retains the same scope as the proposed rule. A primary purpose of the proposed restrictions is to facilitate the resolution of a GSIB outside of Title II, including under the U.S. Bankruptcy Code. As discussed in the Background section, the potential for the mass exercise of QFC default rights is a major reason why the failure of a global systemically important BHC could have a severe negative impact on financial stability and on the Federal banking system. In the context of an SPOE resolution, if the global systemically important BHC's entry into resolution triggers the mass exercise of cross-default rights by the subsidiaries' QFC counterparties of the covered QFCs against the covered bank, then the national bank or FSA could themselves experience financial distress or failure. Moreover, the mass exercise of covered QFC default rights would entail asset fire sales, which could affect other U.S. financial companies and undermine financial stability of the U.S. financial system. Similar disruptive results can occur with an MPOE resolution of an affiliate of an otherwise performing covered bank that triggers default rights on QFCs against the performing covered bank.

In an SPOE resolution, this damage can be avoided if actions of the following two types are prevented: The exercise of direct default rights against the top-tier holding company that has entered resolution, and the exercise of cross-default rights against the national bank and FSA subsidiaries and other operating subsidiaries based on their parent BHC entry into resolution. Direct default rights against the national bank or FSA subsidiary would not be exercisable, because that subsidiary would continue normal operations and would not enter resolution. In an MPOE resolution, this damage occurs from the exercise of default rights against a performing entity based on the failure of an affiliate.

Title II of the Dodd-Frank Act's stay-and-transfer provisions would address both direct default rights and cross-default rights. But, as explained in the Background section, no similar statutory provisions would apply to a resolution under the U.S. Bankruptcy Code. The final rule attempts to address these obstacles to orderly resolution under the U.S. Bankruptcy Code by extending the stay-and transfer-provisions to any type of resolution. Similarly, the final rule would facilitate a transfer of the GSIB parent's interests in its subsidiaries, along with any credit enhancements it provides for those subsidiaries, to a solvent financial company by prohibiting covered banks from having QFCs that would allow the QFC counterparty to prevent such a transfer or to use it as a ground for exercising default rights.

Accordingly, the final rule is intended to enhance the potential for orderly resolution of a GSIB under the U.S. Bankruptcy Code, the FDI Act, or similar resolution proceedings. In doing so, the proposed rule would advance the Dodd-Frank Act's goal of making the orderly resolution of a covered bank workable under the U.S. Bankruptcy Code.110

Likewise, the final rule retains the prohibition against contractual provisions that permit the exercise of default rights that are indirectly related to the resolution of an affiliate. QFCs may include a number of default rights triggered by an event that is not the resolution of an affiliate but is caused by the resolution, such as a credit rating downgrade in response to the resolution. A primary purpose of the final rule is to prevent early terminations caused by the resolution of an affiliate. A regulation that specifies each type of early termination provision that should be stayed would be over-inclusive, under-inclusive, and easy to evade. Similarly, a stay of default rights that are only directly related to the resolution of an affiliate could increase the likelihood of litigation to determine if the relationship between the default right and the affiliate resolution was sufficient to be considered “directly” related. The final rule attempts to decrease such uncertainty and litigation risk by including default rights that are related (i.e., directly or indirectly) to the resolution of an affiliate.

Moreover, the final rule does not affect parties' rights under the U.S. Bankruptcy Code. As explained above, the final rule does not prohibit a covered QFC from permitting the exercise of default rights against a covered entity that has entered bankruptcy proceedings.111 Therefore, counterparties to a covered entity in bankruptcy would be able to exercise their existing contractual default rights to the full extent permitted under any applicable safe harbor to the automatic stay of the U.S. Bankruptcy Code.

The final rule could also prevent the disorderly failure of the national bank or FSA subsidiary and allow it to continue normal operations. In addition, while it may be in the individual interest of any given counterparty to exercise any available contractual rights to run on the national bank or FSA subsidiary, the mass exercise of such rights could harm the collective interest of all the counterparties by causing the subsidiary to fail. Therefore, like the automatic stay in bankruptcy, which also serves to maximize creditors' ultimate recoveries by preventing a disorderly liquidation of the debtor, the proposed rule would mitigate this collective action problem to the benefit of the creditors and counterparties of covered banks by preventing a disorderly resolution. And because many of these counterparties and creditors are themselves covered banks, or other systemically important financial firms, improving outcomes for these creditors and counterparties would further protect the safety and soundness of the Federal banking system and financial stability of the United States.

Proposed Rule and Final Rule. While the proposed restrictions would facilitate orderly resolution, they would also have the effect of diminishing the ability of the counterparties of the covered banks to include protections for themselves in covered QFCs. In order to reduce this effect, the final rule, like the proposed rule, includes several significant exceptions to the proposed restrictions. These permitted creditor protections are intended to allow creditors to exercise cross-default rights outside of an orderly resolution of a GSIB, and therefore would not be expected to undermine such a resolution.

First, in order to ensure that the proposed prohibitions would apply only to cross-default rights (and not direct default rights), the final rule would provide that a covered QFC may permit the exercise of default rights based on the direct party's entry into a resolution proceeding.112 This provision helps to ensure that, if the direct party to a QFC were to enter bankruptcy, its QFC counterparties could exercise any relevant direct default rights. Thus, direct QFC counterparties of a covered bank's subsidiary or affiliate would not risk the delay and expense associated with becoming involved in a bankruptcy proceeding, and would be able to take advantage of default rights that would fall within the U.S. Bankruptcy Code's safe harbor provisions.

The final rule also allows covered QFCs to permit the exercise of default rights based on the failure of (1) the direct party, (2) a covered affiliate support provider, or (3) a transferee that assumes a credit enhancement to satisfy its payment or delivery obligations under the direct QFC or credit enhancement. Moreover, the final rule would allow covered QFCs to permit the exercise of a default right in one QFC that is triggered by the direct party's failure to satisfy its payment or delivery obligations under another contract between the same parties. This exception takes appropriate account of the interdependence that exists among the contracts in effect between the same counterparties.

As explained in the proposed rule, the exceptions in the final rule for the creditor protections described are intended to help ensure that the proposed rule permits a covered bank's QFC counterparties to protect themselves from imminent financial loss and does not create a risk of delivery gridlocks or daisy-chain effects, in which a covered bank's failure to make a payment or delivery when due leaves its counterparty unable to meet its own payment and delivery obligations. The daisy-chain effect would be prevented because the covered bank's counterparty would be permitted to exercise its default rights, such as by liquidating collateral. These exceptions are generally consistent with the treatment of payment and delivery obligations under the U.S. Special Resolution Regimes.113

These exceptions also help to ensure that the counterparties of a covered bank's subsidiaries or affiliates would not risk the delay and expense associated with becoming involved in a bankruptcy proceeding, since, unlike a typical creditor of an entity that enters bankruptcy, the QFC counterparty would retain its ability under the U.S. Bankruptcy Code's safe harbors to exercise direct default rights. This should further reduce the counterparty's incentive to run. Reducing incentives to run in the period leading up to resolution promotes orderly resolution because a QFC creditor run (such as a mass withdrawal of repo funding) could lead to a disorderly resolution and pose a threat to financial stability.

Proposed Rule and Final Rule. The final rule, like the proposed rule, allows the inclusion of additional creditor protections for a non-defaulting counterparty that is the beneficiary of a credit enhancement from an affiliate of the covered bank that is also a covered bank under the final rule or a covered entity under the FRB final rule. The final rule would allow these creditor protections in recognition of the supported party's interest in receiving the benefit of its credit enhancement. The OCC, FRB, and FDIC believe that these creditor protections would not undermine an SPOE resolution of a GSIB.114

Where a covered QFC is supported by a covered affiliate credit enhancement,115 the covered QFC and the credit enhancement would be permitted to allow the exercise of default rights under the circumstances after the expiration of a stay period. Under the final rule, the applicable stay period would begin when the credit support provider enters resolution and would end at the later of 5:00 p.m. (eastern time) on the next business day and 48 hours after the entry into resolution. This portion of the final rule is similar to the stay treatment provided in a resolution under the OLA or the FDI Act.116

Under the final rule, contractual provisions may permit the exercise of default rights at the end of the stay period if the covered affiliate credit enhancement has not been transferred away from the covered affiliate support provider and that support provider becomes subject to a resolution proceeding other than a proceeding under Chapter 11 of the U.S. Bankruptcy Code.117 Covered QFCs may also permit the exercise of default rights at the end of the stay period if the transferee (if any) of the credit enhancement enters a resolution proceeding, protecting the supported party from a transfer of the credit enhancement to a transferee that is unable to meet its financial obligations.

QFCs may also permit the exercise of default rights at the end of the stay period if the original credit support provider does not remain, and no transferee becomes obligated to the same (or substantially similar) extent as the original credit support provider was obligated immediately prior to entering a resolution proceeding (including a Chapter 11 proceeding) with respect to (a) the covered affiliate credit enhancement, (b) all other covered affiliate credit enhancements provided by the credit support provider on any other covered QFCs between the same parties, and (c) all credit enhancements provided by the credit support provider between the direct party and affiliates of the direct party's QFC counterparty. Such creditor protections are permitted to prevent the support provider or the transferee from “cherry picking” by assuming only those QFCs of a given counterparty that are favorable to the support provider or transferee. Title II of the Dodd-Frank Act and the FDI Act contain similar provisions to prevent cherry picking.

Finally, if the covered affiliate credit enhancement is transferred to a transferee, then the non-defaulting counterparty could exercise default rights at the end of the stay period unless either (a) all of the support provider's ownership interests in the direct party are also transferred to the transferee or (b) reasonable assurance is provided that substantially all of the support provider's assets (or the net proceeds from the sale of those assets) will be transferred to the transferee in a timely manner. These conditions would help to assure the supported party that the transferee generally would be at least as financially capable of providing the credit enhancement as the covered affiliate support provider.

Comments. Commenters generally expressed strong support for these exclusions but also requested that these exclusions be broadened in a number of ways. Some commenters urged the OCC to broaden the exclusions to permit, after the trigger of the stay-and-transfer provisions, the exercise of default rights by a counterparty against a direct counterparty or covered support provider with respect to any default right under the QFC (other than a default right explicitly based on the failure of an affiliate) and not just with respect to defaults resulting from payment or delivery failure or the direct party becoming subject to certain resolution or insolvency proceedings (e.g., failure to maintain a license or certain capital level, materially breaching its representations under the QFC). Some commenters contended that, at a minimum, the final rule should provide for creditor protections that meet the minimum standards set forth by the Universal Protocol. One commenter specifically identified three creditor protections found in the Universal Protocol that it argued the OCC should include in § 47.5: (1) Priority rights in a bankruptcy proceeding against the transferee or original credit support provider (if the QFC providing credit support was not transferred); (2) a right to submit claims in the insolvency proceeding of the insolvent credit support provider if the transferee becomes insolvent; and (3) the ability to declare a default and close out of both the original QFC with the direct counterparty as well as QFCs with the transferee if the transferee defaults under the transferred QFC or under any other QFC with the non-defaulting counterparty, subject to the contractual terms and consistent with applicable law. Another commenter argued for creditor protections not found in the Universal Protocol, including that the transferee be required to be a U.S. person and be registered with and licensed by the primary regulator of either the direct counterparty or transferor entity.

The final rule does not include the additional creditor protections of the Universal Protocol or other creditor protections requested by commenters. As explained in the proposed rule and below, the additional creditor protections of the Universal Protocol do not appear to materially diminish the prospects for an orderly resolution of a GSIB because the Universal Protocol includes a number of desirable features that the final rule otherwise lacks.118 Providing additional circumstances under which default rights may be exercised during and immediately after the stay period, in the absence of any counterbalancing benefits to resolution, would increase the risk of a disorderly resolution of a GSIB in contravention of the purposes of this final rule.

One commenter also argued that transfer should be limited to a bridge bank under the FDI Act or a bridge financial company under Title II of the Dodd-Frank Act to ensure that the transferee is more likely to be able to satisfy the obligations of a credit support provider and is subject to regulatory oversight. Section 47.5 of the final rule permits QFCs to include provisions allowing a counterparty to exercise its default rights against a direct party that enters resolution under the FDI Act or Title II of the Dodd-Frank Act, other than the limited case contemplated by § 47.5(h) of the final rule. The OCC is not adopting the proposed additional creditor protection because it would defeat in large part the purpose of § 47.5 and potentially create confusion regarding the requirements and purposes of sections 47.4 and 47.5 of the final rule.119

A few commenters expressed concern that the additional creditor protections applied only to QFCs supported by a credit enhancement provided by a “covered affiliate support provider” (i.e., an affiliate that is a covered entity, covered bank, or covered FSI) and noted that Foreign GSIBs often will have their QFCs supported by a non-U.S. affiliate that is not a covered entity, covered bank, or covered FSI. Such non-U.S. affiliate credit supporter providers would not be able to rely on the additional creditor protections for supported QFCs. As the FRB Proposed Rule explained, “[s]uch credit enhancements [are] excluded in order to help ensure that the resolution of a non-[U.S.] entity would not negatively affect the financial stability of the United States by allowing for the exercise of default rights against a covered entity [or in the case of the OCC Proposed Rule, the covered bank].” 120

One commenter requested clarification that the creditors of a non-U.S. credit support provider are permitted to exercise any and all rights against that non-U.S. credit support provider that they could exercise under the non-U.S. resolution regime applicable to that non-U.S. credit support provider. In general, covered banks may be entities organized or operating in the United States or, with respect to U.S. GSIBs, abroad. The final rule, like the proposed rule, is limited to QFCs to which a covered bank is a party. Section 47.5 of the final rule generally prohibits QFCs to which a covered bank is a party from allowing the exercise of cross-default rights of the covered QFC, regardless of whether the affiliate entering resolution and/or the credit support provider is organized or operates in the United States.

Another commenter expressed concern that the proposed § 47.5(g)(3) (§ 47.5(f)(3) of the final rule) would provide a right without a remedy because, if the covered affiliate credit support provider is no longer obligated and no transferee has taken on the obligation, the non-covered entity counterparty may have only a breach of contract claim against an entity that has transferred all of its assets to a third party. The creditor protections of § 47.5, if triggered, permit contractual provisions allowing the exercise of existing default rights against the direct party to the covered QFC, as well as any existing rights against the credit enhancement provider. Another commenter suggested revising proposed § 47.5(g) (§ 47.5(f) of the final rule) to clarify that, for a covered direct QFC supported by a covered affiliate credit enhancement, the covered direct QFC and the covered affiliate credit enhancement may permit the exercise of a default right after the stay period that is related, directly or indirectly, to the covered affiliate support provider entering into resolution proceedings. This reading is incorrect and revising the final rule as requested would largely defeat the purpose of § 47.5 of the final rule by merely delaying QFC termination en masse.

Some commenters also requested specific provisions related to physical commodity contracts, including a provision that would allow regulators to override a stay if necessary to avoid disruption of the supply or prevent exacerbation of price movements in a commodity or a provision that would allow the exercise of default rights of counterparties delivering or taking delivery of physical commodities if a covered bank defaults on any physical delivery obligation to any counterparty. As noted above, QFCs may permit a counterparty to exercise its default rights immediately, even during the stay period, if the covered bank fails to pay or perform on the covered QFC with the counterparty (or another contract between the same parties that gives rise to a default under the covered QFC).

Proposed Rule and Final Rules. In the case of a covered QFC that is supported by a covered affiliate credit enhancement, both the covered QFC and the credit enhancement would be permitted to allow the exercise of default rights related to the credit support provider's entry into resolution proceedings under the FDI Act 121 only under the following circumstances: (a) After the FDI Act stay period,122 if the credit enhancement is not transferred under the relevant provisions of the FDI Act 123 and associated regulations, and (b) during the FDI Act stay period, to the extent that the default right permits the supported party to suspend performance under the covered QFC to the same extent as that party would be entitled to do if the covered QFC were with the credit support provider itself and were treated in the same manner as the credit enhancement. This provision is intended to ensure that a QFC counterparty of a subsidiary of a covered bank that goes into FDI Act receivership can receive the same level of protection that the FDI Act provides to QFC counterparties of the covered bank itself. No comments were received on this aspect of the proposed rule, and the final rule remains unchanged.

Proposed Rule. In case of a legal dispute as to a party's right to exercise a default right under a covered QFC, the proposed rule required that a covered QFC must provide that, after an affiliate of the direct party has entered a resolution proceeding, (a) the party seeking to exercise the default right shall bear the burden of proof that the exercise of that right is indeed permitted by the covered QFC and (b) the party seeking to exercise the default right must meet a “clear and convincing evidence” standard, a similar standard,124 or a more demanding standard.

This proposed requirement was intended to prevent QFC counterparties from circumventing the limitations on resolution-related default rights in this proposal by exercising other contractual default rights in instances where such QFC counterparty cannot demonstrate that the exercise of such other contractual default rights is unrelated to the affiliate's entry into resolution.

Comments. A few commenters requested guidance on how to satisfy the burden of proof of clear and convincing evidence so that they may avoid seeking such clarity through litigation. Other commenters urged that this standard was not appropriate and should be eliminated. In particular, a number of commenters expressed concern that the burden of proof requirements, which are more stringent than the burden of proof requirements for typical contractual disputes adjudicated in a court, unduly hamper the creditor protections of counterparties and impose a burden directly on non-covered entities, who should be able to exercise default rights if it is commercially reasonable in the context. One commenter contended that this burden, combined with the stay on default rights related “indirectly” to an affiliate entering insolvency proceedings, effectively prohibits counterparties from exercising any default rights during the stay period. These commenters argued that it is inappropriate for the OCC by regulation to alter the burden of proof for contractual disputes. One commenter suggested that, in a scenario involving a master agreement with some transactions out of the money and others in the money, the defaulting GSIB will have a lower burden of proof for demonstrating that it is owed money than for demonstrating that it owes money, should the non-GSIB counterparty exercise its termination rights. Certain commenters suggested instead that the final rule shift the burden and adopt a rebuttable presumption that the non-defaulting counterparty's exercise of default rights is permitted under the QFC unless the defaulting covered entity demonstrates otherwise. One commenter requested that the burden of proof not apply to the exercise of direct default rights.

Final Rule. The final rule retains the proposed burden of proof requirements. The requirement is based on a primary goal of the final rule—to avoid the disorderly termination of QFCs in response to the failure of an affiliate of a GSIB. The requirement accomplishes this goal by making clear that a party that exercises a default right when an affiliate of its direct party enters receivership of insolvency proceedings is unlikely to prevail in court unless there is clear and convincing evidence that the exercise of the default right against a covered entity is not related to the insolvency or resolution proceeding. The requirement therefore should discourage the impermissible exercise of default rights without prohibiting the exercise of all default rights. Moreover, the burden of proof requirement should not discourage the exercise of default rights after or in response to a failure to satisfy a creditor protection provision (e.g., direct default rights); such a failure should be easily evidenced, even under a heightened burden of proof, such that clarification through court proceedings should not be necessary.

Proposed Rule. In addition to entering into QFCs as principal, GSIBs may engage in QFCs as agent for other principals. For example, a GSIB subsidiary may enter into a master securities lending arrangement with a foreign bank as agent for a U.S.-based pension fund. The GSIB would document its role as agent for the pension fund, often through an annex to the master agreement, and would generally provide to its customer (the principal party) a securities replacement guarantee or indemnification for any shortfall in collateral in the event of the default of the foreign bank.125 A covered bank may also enter into a QFC as principal where there is an agent acting on its behalf or on behalf of its counterparty.

The proposed rule would have applied to a covered QFC regardless of whether the covered bank or the covered bank's direct counterparty is acting as a principal or as an agent. The proposed rule did not distinguish between agents and principals with respect to default rights or transfer restrictions applicable to covered QFCs. The proposed rule would have limited default rights and transfer restrictions that the principal and its agent may have against a covered bank consistent with the U.S. Special Resolution Regimes. The proposed rule would have ensured that, subject to the enumerated creditor protections, neither the agent nor the principal could exercise cross-default rights under the covered QFC against the covered bank based on the resolution of an affiliate of the covered bank.126

Comments. Commenters argued that the provisions of sections 47.4 and 47.5 that relate to transactions entered into by the covered bank as agent should exclude QFCs where the covered bank or its affiliate does not have any liability (including contingent liability) under or in connection with the contract, or any payment or delivery obligations with respect thereto. Commenters also argued that the proposed agent provisions should not apply to circumstances where the covered bank acts as agent for a counterparty whose transactions are excluded from the requirements of the final rule.127 Commenters provided as an example where an agent simply executes an agreement on behalf of the principal but bears no liability thereunder, such as where an investment manager signs an agreement on behalf of a client. Commenters noted that such agreements could contain events of default relating to the insolvency of the agent or an affiliate of the agent but that such default rights would be difficult to track and that close-out of such QFCs would not result in any loss or liquidity impact to the agent. Rather, early termination under the agreements would subject the cash and securities of the principals—not the agent—to realization and liquidation. Therefore, the agent would not be exposed to the liquidity and asset fire sale risks the proposed rule was intended to address.

Commenters contended that the requirement to conform QFCs with all affiliates of a counterparty when an agent is acting on behalf of the counterparty would be particularly burdensome, as the agent may not have information about the counterparty's affiliates or their contracts with covered entities. Commenters also requested clarification that conformance is not required of contracts between a covered entity as agent on behalf of a non-U.S. affiliate of a Foreign GSIB that would not be a covered bank under the proposed rule, since default rights related to the non-U.S. operations of Foreign GSIBs are not the focus of the rule and do not bear a sufficient connection to U.S. financial stability to warrant the burden and cost of compliance.

One commenter also urged that securities lending authorization agreements (SLAAs) should be exempt from the final rule. The commenter explained that SLAAs are banking services agreements that establish an agency relationship with the lender of securities and an agent, and may be considered credit enhancements for securities lending transactions (and therefore QFCs) because the SLAAs typically require the agent to indemnify the lender for any shortfall between the value of the collateral and the value of the securities in the event of a borrower default. The commenter explained that SLAAs typically do not contain provisions that may impede the resolution of a GSIB, but may contain termination rights or contractual restrictions on assignability. However, the commenter argued that the beneficiaries under SLAAs lack the incentive to contest the transfer of the SLAA to a bridge institution in the event of GSIB insolvency.

Final Rule. To respond to concerns raised by commenters, the agency provisions of the proposed rule have been modified in the final rule. The final rule provides that a covered bank does not become a party to a QFC solely by acting as agent to a QFC.128 Therefore, an in-scope QFC would not be a covered QFC solely because a covered bank was acting as the agent of a principal with respect to the QFC.129 For example, the final rule would not require a covered bank to conform a master securities lending arrangement (or the transactions under the agreement) to the requirements of the final rule if the only obligations of the covered bank under the agreement are to act as an agent on behalf of one or more principals. This modification should address many of the concerns raised by commenters.

The final rule does not specifically exempt SLAAs because the agreements provide the beneficiaries with contractual rights that may hinder the orderly resolution of a GSIB and because it is unclear how such beneficiaries would act in response to the failure of their agent. More generally, the final rule does not exempt a QFC with respect to which an agent also acts in another capacity, such as guarantor. Continuing the example regarding the covered bank acting as agent with respect to a master securities lending agreement, if the covered entity also provided a SLAA that included the typical indemnification provision discussed above, the agency exemption of the final rule would not exclude the SLAA but would still exclude the master securities lending agreement. This is because the covered bank is acting solely as agent with respect to the master securities lending agreement but is acting as agent and guarantor with respect to the SLAA. However, SLAAs would be exempted under the final rule to the extent that they are not “in-scope QFCs” or otherwise meet the exemptions for covered QFCs of the final rule.

Proposed Rule and Final Rule. Commenters also requested that the final rule should clarify that obligations under a QFC would still be enforceable even if its terms do not comply with the requirements of the final rule, similar to assurances provided in respect of the U.K. rule and German legislation. The enforceability of a contract is beyond the scope of this final rule.

Proposed Rule and Final Rule. Certain commenters requested clarification that amending covered QFCs as required by this final rule should not trigger other regulatory requirements for covered banks, such as the swap margin requirements issued by the OCC, other prudential regulators (FRB, FDIC, Farm Credit Administration, and Federal Housing Financing Agency), and the U.S. Commodity Futures Trading Commission (CFTC). In particular, commenters urged that amending a swap to conform to this final rule should not jeopardize the status of the swap as a legacy swap for purposes of the swap margin requirements for non-cleared swaps.

These issues are outside the scope of this final rule as they relate to the requirements of another rule issued by the OCC jointly with the other prudential regulators, as well as a rule issued by the CFTC. As commenters pointed out, addressing such issues may require consultation with the other prudential regulators as well as the CFTC and the U.S. Securities and Exchange Commission to determine the impact of the amendments required by this final rule for purposes of the regulatory requirements under Title VII of the Dodd-Frank Act. However, as the proposed rule noted, the OCC is considering an amendment to the definition of “eligible master netting agreement” to account for the restrictions on covered QFCs and is consulting with the other prudential regulators and the CFTC on this aspect of the final rule.130 The OCC does not expect that compliance with this final rule would trigger the swap margin requirements for non-cleared swaps.

Proposed Rule. The proposed rule allowed covered banks to conform covered QFCs to the requirements of the proposed rule through adherence to the Universal Protocol. The Universal Protocol has two primary operative provisions, Section 1 and Section 2. Under Section 1, adhering parties essentially “opt in” to the U.S. Special Resolution Regimes and certain other special resolution regimes. Therefore, Section 1 is generally responsive to the concerns addressed in § 47.4 of the proposed rule. Under Section 2, adhering parties essentially forego, subject to the creditor protections of Section 2, cross-default rights and transfer restrictions on affiliate credit enhancements. Therefore, Section 2 is generally responsive to the concerns addressed in § 47.5 of the proposed rule.

The proposed rule noted that, while the scope of the stay-and-transfer provisions of the Universal Protocol are narrower than the stay-and-transfer provisions that would have been required under the proposed rule, and the Universal Protocol provides a number of creditor protection provisions that would not otherwise have been available under the proposed rule, the Universal Protocol includes a number of desirable features that the proposed rule lacked. The proposed rule explained that “when an entity (whether or not it is a covered bank) adheres to the [Universal] Protocol, it necessarily adheres to the [Universal] Protocol with respect to all covered entities that have also adhered to the [Universal] Protocol rather than one or a subset of covered entities (as the [proposed rule] may otherwise permit). . . . By allowing for all covered QFCs to be modified by the same contractual terms, this 'all-or-none' feature would promote transparency, predictability and equal treatment with respect to default rights of non-defaulting parties.” 131 This “all-or-none” feature is referred to as “universal adherence” in the remainder of this preamble. The proposed rule explained that the Universal Protocol included other favorable features, which include that it amends all existing transactions of adhering parties, does not provide the counterparty with default rights in addition to those provided under the underlying QFC, applies to all QFCs, and includes resolution under bankruptcy as well as U.S. and certain non-U.S. Special Resolution Regimes. Because the features of the Universal Protocol, considered together, appeared to increase the likelihood that the resolution of a GSIB under a range of scenarios could be carried out in an orderly manner, the proposal stated that QFCs amended by the Universal Protocol would have been consistent with the proposal, notwithstanding differences from § 47.5 of the proposed rule.

Comments and Final Rule. Commenters generally supported the proposed rule's provisions to allow covered banks to comply with the requirements of the proposed rule through adherence to the Universal Protocol. For the reasons discussed in this preamble and in the proposed rule, the final rule continues to allow covered banks to comply with the rule through adherence to the Universal Protocol and makes other modifications to the proposed rule to address comments.

A few commenters requested that the final rule clarify two technical aspects of adherence to the Universal Protocol. These commenters requested confirmation that adherence to the Universal Protocol would also satisfy the requirements of § 47.4. The commenters also requested confirmation that QFCs that incorporate the terms of the Universal Protocol by reference also would be deemed to comply with the terms of the proposed alternative method of compliance.132 By clarifying § 47.6(a), the final rule confirms (1) that adherence to the Universal Protocol is deemed to satisfy the requirements of § 47.4 of the final rule (as well as § 47.5) and (2) that conformance of a covered QFC through the Universal Protocol includes incorporation of the terms of the Universal Protocol by reference by protocol adherents. This clarification also applies to the U.S. Protocol, discussed below.

One commenter indicated that many non-covered entity counterparties do not have ISDA master agreements for physically-settled forward and commodity contracts and, therefore, compliance with the proposed rule's requirements through adherence to the Universal Protocol would entail substantial time and educational effort. As in the proposed rule, the final rule simply permits adherence to the Universal Protocol as one method of compliance with the final rule's requirements, and parties may meet the final rule's requirements through bilateral negotiation, if they choose. Moreover, the Securities Financing Transaction Annex and Other Agreements Annex of the Universal Protocol, which are specifically identified in the proposed and final rule, are designed to amend QFCs that are not ISDA master agreements.

Proposed Rule and Comments. In addition to the Universal Protocol, many commenters argued that the final rule should allow compliance with the final rule through a yet-to-be-created “U.S. Jurisdictional Module to the ISDA Resolution Stay Jurisdictional Modular Protocol” (an “approved U.S. JMP”) that is generally the same but narrower in scope than the Universal Protocol.133 Many non-GSIB commenters argued that they were not involved with the drafting of the Universal Protocol and that an approved U.S. JMP would create a level playing field between those that were involved in the drafting and those that were not. In general, commenters identified two aspects of the Universal Protocol that they argued should be narrowed in the approved U.S. JMP: The scope of the special resolution regimes and the universal adherence feature of the Universal Protocol.

With respect to the scope of the special resolution regimes of the Universal Protocol, commenters' concern focused on the special resolution regimes of “Protocol-eligible Regimes.” Some commenters also expressed concern with the scope of “Identified Regimes” of the Universal Protocol.

The Universal Protocol defines “Identified Regimes” as the special resolution regimes of France, Germany, Japan, Switzerland, and the United Kingdom, as well as the U.S. Special Resolution Regimes. The Universal Protocol defines “Protocol-eligible Regimes” as resolution regimes of other jurisdictions specified in the protocol that satisfies the requirements of the Universal Protocol. The Universal Protocol provides a “Country Annex,” which is a mechanism by which individual adherents to the Universal Protocol may agree that a specific jurisdiction satisfies the requirements of a “Protocol-eligible Regime.” The Universal Protocol referred to in the proposed rule did not include any Country Annex for any Protocol-eligible Regime.134