Fed netting reg would treat more entities as ‘financial institutions’ under proposal

More categories of entities would be defined as “financial institutions” under federal rules affecting netting contracts under a proposed rule issued by the Federal Reserve Board for a 60-day public comment period.

The proposed revisions, scheduled for publication in the Federal Register Thursday, would apply to the Fed’s Regulation EE, which implements the netting provisions of the 1991 Federal Deposit Insurance Corporation Improvement Act (FDICIA). The Fed’s proposal would also clarify how the existing activities-based test in Regulation EE applies following a consolidation of legal entities.

The FDICIA netting provisions apply to bilateral netting contracts between two financial institutions and multilateral netting contracts among members of a clearing organization. Their aim is to ensure that netting contracts will be enforced even in the event that one of the parties becomes insolvent.

FDICIA defined “financial institution” to include a depository institution, a securities broker or dealer, a futures commission merchant, or any other institution as determined by the Fed Board. In Regulation EE, the Fed Board broadened the definition of “financial institution” by using an activities-based test that includes a qualitative component and a quantitative component. The qualitative component requires that the person “represent[], orally or in writing, that it will engage in financial contracts as a counterparty on both sides of one or more financial markets,” the Fed’s notice of proposed rulemaking states. The quantitative component requires that the person have either (1) one or more financial contracts of a total gross dollar value of at least $1 billion in notional principal amount outstanding on any day during the previous 15-month period with counterparties that are not its affiliates or (2) total gross mark-to-market positions of at least $100 million (aggregated across counterparties) in one or more financial contracts on any day during the previous 15-month period with counterparties that are not its affiliates.

The Fed has not expanded the definition of “financial institution” in Reg EE to include institutions or individuals who are end users and not market intermediaries, though it says it has issued a limited number of case-by-case “financial institution” determinations with respect to certain government-sponsored end users and members in a large-value fund transfer system.

That said, one of the key issues on which the Fed seeks comment is whether Reg EE should be revised specifically to define the following as financial institutions:

  • Swap dealers and security-based swap dealers
  • Major swap participants and major security-based swap participants
  • Nonbank systemically important financial institutions
  • Certain financial market utilities, including derivatives clearing organizations and clearing agencies, and financial market utilities designated as systemically important by the Financial Stability Oversight Council)
  • Foreign banks
  • Bridge institutions
  • Federal Reserve Banks

Input is also sought on including entities defined in the Fed’s regulations as qualifying central counterparties.

Regarding Reg EE’s activities-based test, the Fed proposes to clarify the meaning of the “15-month” period noted in the qualitative component; and address situations in which one of the entities in a consolidation has not, on its own, met the quantitative thresholds provided in the test.

Reg lookup: Netting Eligibility for Financial Institutions