The Board of Governors of the Federal Reserve System (the "Board") has adopted final rules1 that represent a significant shift in the terms of over-the-counter derivatives, repurchase and reverse repurchase transactions and securities lending transactions. These rules will require buy-side firms to relinquish certain termination rights that have long been part of bankruptcy "safe harbors" for these types of contracts under bankruptcy and insolvency regimes in many jurisdictions in order to continue trading with large financial institutions. The new rules will impact institutional investors, hedge funds, mutual funds, sovereign wealth funds and other buy-side market participants who enter into over-the-counter derivatives, repurchase and reverse repurchase transactions and securities lending transactions with large financial institutions.
From a policy perspective, these rules are part of post-financial crisis efforts by regulators in various jurisdictions to create a framework for directing an orderly resolution of a distressed systemically important financial institution, including the institution's derivatives transactions. These regimes, including Title II of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"), generally impose a one or two business day stay on the exercise of default rights (such as termination rights and rights to net collateral) by creditors of a distressed financial institution, to give the applicable receiver or regulatory body time to transfer the financial institution's rights and obligations to another entity. Following such a transfer, the non-defaulting party's right to exercise default rights as a result of its counterparty (or an affiliate of its counterparty) entering the proceedings is extinguished.
The cross-border enforceability of these special resolution regimes is unclear under current law. The rules seek to provide clarity with respect to the enforceability of the U.S. special resolution regimes2 by requiring parties to covered financial contracts to "opt into" the applicability of these regimes by contract. In effect, parties to covered financial contracts will agree to be bound by the U.S. special resolution regimes, even in situations where the regimes might not otherwise apply. Comparable regulations have been adopted in Germany, Japan and the United Kingdom, and are being adopted in other jurisdictions.
Under comparable regulations in certain jurisdictions,...