What’s your involvement in securities lending?
I’m currently a partner in Perkins Coie’s investment management team. I primarily advise clients on securities lending, repo, derivatives and other investment related activities. My client base is primarily the buy-side or end users, with smaller broker dealers and banks. I do not generally represent any of the global systemically important banks (GSIBs) or the global banks on their activities. Prior to that, I was part of Reed Smith’s’ Investment Management team for 12 years. I also worked in-house in the legal department at Federated Investors.
What is the final rule and how will it affect securities financing, specifically repo?
The main goal of the final rule is to facilitate the orderly resolution of GSIBs. To accomplish this, the Federal Reserve is seeking to limit the ability of the GSIBs trading counterparties to terminate their trades with a GSIB immediately upon the GSIB going into a resolution regime.
So they’re concerned about a mass termination of trading agreements or contracts immediately upon the GSIB going into a resolution regime. In the US, the two main applicable resolution regimes are the Dodd-Frank Liquidation Authority, and the Federal Deposit Insurance Corporation’s (FDIC) which are both similar. The final rule is really an effort to make sure that those regimes are enforced regardless of which court is involved in a proceeding seeking to enforce the terms of a trading agreement with the GSIB.
Specifically, there’s concern that a foreign court could disregard the applicability of the resolution regimes in the US and ignore the stay requirements that are in those resolution regimes. In order to address the risk that foreign courts will ignore the statutory provisions, the final rule, in essence embedded the applicability of the regimes, and the associated stay requirements into trading agreements contracts. The affected contracts referred to in the final rule, known as ‘qualified financial contracts’ (QFCs), include repo and securities lending contracts.
Have you heard any feedback from the street on how this final version was received?
I have had several clients reach out to me on this issue. I know some of the trade groups are discussing issues in their committees. But I still feel like most of the street, at least on the buy side, are still digesting the rule and trying to plan out how it affects them. I have not seen much in the way of implementation. The key date is
1 January 2019 and I expect the GSIBs will seek to have their trading documentation amended by such date.
Are you surprised at the lack of activity on this so far, given the scale of the rule?
I think more education would be helpful, and certainly could not hurt, as it is a complex rule. When you add in the addition of having to understand the ISDA protocols it can be a tough lift for firms to get their arms around. Once a firm has an understanding of the rule and the ISDA protocols, it will have to survey its universe of trading agreements and catalog the agreements that will be required to be amended. Finally, they will have to consider whether they want to amend those agreements by entering into an ISDA protocol or by entering into bilateral amendments with their counterparties.
How do you envisage buy-side firms using this guide?
My colleague and I run a blog that is really geared to the buy side. But since it’s a blog we try to provide short and concise guidance to our readers. So the guide that I wrote is not supposed to be an all encompassing summary of the final rule, but the goal of it is to succinctly outline what the final rule does and give our viewers an overview of it and what people can do to try and prepare for it. We expect to see implementation issues arise and I will probably have to amend the guide or write separate posts to address the implementation issues that I see the buy side encountering.
How does the final version of the rule differ from initial drafts?
The Federal Reserve did put in several helpful exemptions, that were not in the proposed rule. The most helpful being the one that states if for example, a repo agreement is subject to US law, and all parties to the agreement are incorporated or domiciled in the US and the agreement does not otherwise disclaim the applicability of the US resolution regime, then there’s no requirement to amend your documentation.
The theory is that there’s very little risk that such contracts will not be governed by the US resolution regimes. But in terms of repo counterparties what the Federal Reserve added was a helpful exception to the rule.
How will the final rule affect contractual default rights for QFCs, including repo and securities lending contracts?
The applicability of the FDIC and the Dodd-Frank regimes will now be contractually incorporated into repo and securities lending contracts. That is the main amendment we are talking about and includes the 48-hour stay on termination of such contracts upon the GSIB entering a resolution regime. That 48 hours is designed to give the US regulators the chance to move those contracts to a good bank.
There are also several prohibitions of what can’t be in the trading agreements particularly with respect to certain cross default provisions that are tied to an affiliate of the GSIB entering into a bankruptcy or insolvency regime.
Additionally, applicable trading agreements as a general matter may not prohibit a credit enhancement, such as a guarantee, from being transferred in certain situations.
Can you expand on the scale of the re-papering job for banks going forward?
The final rule has a safe harbour for the ISDA Universal Protocol and the yet to be published US protocol which is a separate ISDA protocol. In essence, the Federal Reserve puts forth those protocols as a means to comply with the final rule.
My assumption is that, given the scale of a GSIBs trading agreements, they will likely want their counterparties to adhere to one of the two protocols and thereby amend their documentation to comply with the final rule.
The GSIBs have already adhered to the universal stay protocol, but most buy-side firms have not because that protocol is really designed to be a GSIB to GSIB protocol. My guess, and it’s still early, is that US protocol may become the favoured protocol.