Money managers that have financial contracts with the largest U.S. global banking institutions would not be able to terminate those contracts for 48 hours if the bank failed, under rules proposed Tuesday by the Federal Reserve Board of Governors.
The proposed qualified financial contracts rule would require the banks to include the limited stays in contracts covering derivatives, repurchase agreements, securities lending and borrowing transactions.
The intent is to avoid spreading financial panic in the event of a bank failure and give regulators enough time to transfer the contracts to another bank. “The crisis underscored that when a large financial institution gets into trouble, its failure can destabilize other firms,” said Janet Yellen, board chairwoman, at the meeting where the board voted unanimously to propose the new rule. “In the 21st century, a run on a failing banking organization may begin with the mass cancellation of the derivatives and repo contracts that govern the everyday course of financial transactions,” Ms. Yellen said, and if those contracts unravel all at once, it could make it harder to resolve the bank's status, “sparking asset fire sales that may consume many firms.”
The cost of a final rule, which would be borne by the banks and their counterparties, would be modest, “and would be outweighed by the proposal's benefits for the financial stability of the United States,” a staff memo said.
Federal Reserve officials limited the proposal to contracts with eight banks currently identified as U.S. global systemically important banks: Bank of America Corp., The Bank of New York Mellon Corp., Citigroup Inc., Goldman Sachs Group Inc., J.P. Morgan Chase & Co., Morgan Stanley Inc., State Street Corp. and Wells Fargo & Co. The definition of a qualified financial contract is based on special resolution frameworks for failed financial firms established in bank regulations and the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The proposal will be published in the Federal Register shortly and open for public comment until Aug. 6. It would take effect at least one year after the final rule is issued.
