Janet the Giant Killer


On November 2, 2017, President Donald Trump announced that he would nominate Federal Reserve governor Jerome Powell to replace Janet Yellen as Federal Reserve chair.[1] Trump is breaking with tradition, as it is the first time in nearly four decades that a new president has not asked the sitting Federal Reserve chair to stay on for another term.[2]

With Yellen’s tenure at the Federal Reserve entering its twilight, one cannot help but review her stewardship of the central bank. During Yellen’s time in office, the Federal Reserve made many moves to shore up the American financial system. This past autumn, the Fed enacted a new rule to help prevent another financial meltdown and struck a mighty blow against “too big to fail.”[3]

The new rule, titled “Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions” in the Federal Register,[4] (“82 FR 42882″) requires global systematically important banks (“GSIBs”) to change the language they use in qualified financial contracts (“QFCs”)[5], such as derivatives, securities lending deals, and privately negotiated short-term funding agreements.[6] The Federal Reserve Board finalized the rule on September 1st.[7] The new language prevents these contracts from being immediately canceled if the firm were to enter bankruptcy.[8] If institutions canceled the contracts en masse, it could lead to massive market instability.[9]

“Should these contracts, known collectively as Qualified Financial Contracts, or QFCs, unravel all at once at a failed GSIB, an orderly resolution of that firm can become far more difficult, sparking asset fire sales that can consume many firms[,]” said Federal Reserve Chair Janet Yellen on September 1st.[10]

According to a press release from the Fed, the rule comprises two major requirements.[11] “First, the final rule requires QFCs of GSIBs, including those with foreign counterparties, to clarify that U.S. resolution laws providing for a temporary stay to prevent mass terminations apply to the contracts. Second, the final rule prohibits the QFCs of GSIBs from allowing the exercise of default rights that could spread the bankruptcy of one GSIB entity to its solvent affiliates.”[12]

The rule necessitates a “safe harbor,”—a temporary halt to a firm’s ability to terminate deals when its trading partners collapse.[13] 82 FR 42882 is a step toward preventing another global financial crisis by restraining GSIBs; forestalling the cataclysmic damage on the greater financial system should the institutions go bankrupt.[14] Now regulators will have up to 48 hours after a GSIB files for bankruptcy to transfer those QFCs to a bank that can honor them before the counterparty is able to declare a default.[15] Regulators hope that the “safe harbor” will allow time for themselves or courts to steady the failing firm rather than have to cancel the contracts.[16]

The aim of the stay is to prevent a deluge of cancelations.[17] Ideally, this would help foreclose the possibility of a run on the subsidies actuated if a large number of counterparties scramble to terminate their contracts.[18] This was the case of Lehman Brothers in 2008.[19] The new rule applies to eight major institutions: Bank of America Corp., Goldman Sachs Group Inc., Bank of New York Mellon Corp., Citigroup Inc., JPMorgan Chase & Co., Morgan Stanley, State Street Corp., and Wells Fargo & Co.[20] Another 20 foreign GSIBs with U.S. operations are also covered. The rule also applies to 20 foreign GSIBs that have U.S. operations.[21]

The rule requires uniformity among GSIBs’ QFCs, giving the institutions one year to conform their contracts with each other’s.[22] GSIBs will have 18 months to conform QFCs with most other financial counterparties.[23] GSIBs have two years to conform their QFCs with community banks and all other counterparties.[24] However, QFCs that do not contain default rights or limitations that might undercut the well-ordered resolution of a GSIB are excluded.

Compliance with the new rule, which received unanimous approval from the board of the Federal Reserve,[25] will phase in starting January 1, 2019.[26]

[1] Peter Nicholas, President Trump Says Jerome Powell Is His Choice to Lead Federal Reserve, Wall Street J. (Nov. 2, 2017), https://www.wsj.com/articles/president-trump-picks-jerome-powell-to-lead-federal-reserve-1509652155?tesla=y.

[2] Id.

[3] Michelle Price & Pete Schroeder, Federal Reserve finalizes rules to help unwind big banks, Reuters: #Business News (Sept. 1, 2017, 10:55 AM), https://www.reuters.com/article/us-usa-banks-fed/federal-reserve-finalizes-rules-to-help-unwind-big-banks-idUSKCN1BC576.

[4]Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions, 82 FR 42882 (Sept. 1, 2017).

[5] Federal Reserve Board adopts final rule to enhance financial stability, Press Release, Bd. of Governors of the Fed. Res. Sys. (Sept. 1, 2017), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20170901a.htm.

[6] Price & Schroeder supra note 3.

[7] Id.                                                                                                 

[8] Jesse Hamilton, Fed Demands Wall Street Protections Against Lehman-Like Runs, Bloomberg: Markets (Sept. 1, 2017, 10:40 AM), https://www.bloomberglaw.com/ms/document/X2MF5SRO000000/.

[9] Fed. Press Release supra note 5.

[10] Janet Yellen, Chair, Board of Governors of the Fed. Res. Sys., Opening Statement on the Consideration of a Final Rule Restricting Qualified Financial Contracts (Sept. 1, 2017).

[11] Fed. Press Release supra note 5.

[12] Id.

[13] Price & Schroeder supra note 3.

[14] Id.                                

[15] Jack Newsham, Fed OKs Qualified Financial Contracts Rule For Big Banks, Law360 (Sept. 1, 2017, 2:32 PM), https://www.law360.com/articles/960051/fed-oks-qualified-financial-contracts-rule-for-big-banks.

[16] Hamilton supra note 8.

[17]Fed. Press Release supra note 5.

[18] Price & Schroeder supra note 3.

[19] Id.

[20] Newsham supra note 15.

[21] Id.

[22]Fed. Press Release supra note 5.

[23] Id.

[24] Id.

[25] Price & Schroeder supra note 3.

[26] Fed. Press Release supra note 5.


About Author

Comments are closed.

Fordham Journal of Corporate & Financial Law