Monday, February 10, 2014

NY Fed Chief Concerned about Cross-Border Application of Dodd-Frank Title II

William Dudley, President of the NY Fed,  is concerned about the cross-border orderly resolution of failed and failing financial institutions that come within the scope of  the orderly liquidation authority in Title II of the Dodd-Frank Act. Specifically, in remarks at a Washington seminar on resolution, the Fed senior official expressed concern that Title II’s one-day stay on the close-out of qualified financial contracts is incomplete and does not extend to contracts governed by non-US law with non-US counterparties.

Title II stay. The placement of the parent company into receivership may be treated by these counterparties as an event of default due to the presence of a parent guarantee or other cross-default provisions triggered by the parent-level insolvency. Unless market participants make the appropriate contractual changes that will ensure that the entry of the parent company into Title II will not trigger the close-out provisions of those over-the-counter derivatives and other qualified financial contracts that are outside the reach of Title II’s U.S. application, he reasoned,  foreign counterparties to the systemically important firm will tend to exercise this right whenever it is in their individual economic interest to do so. This would create significant difficulties because such actions could greatly complicate the operations of the firm during a time when it is already under considerable stress and would propagate stress more broadly in financial markets.

The Fed official said that there are two main options for addressing this issue, and they are not mutually exclusive. Existing derivative contracts could be amended and future contracts could provide that the parent’s entry into the Title II proceeding does not trigger the close-out option, or legal changes could be implemented abroad so that the one-day stay that applies to qualified financial contracts governed by U.S. law is enforceable against those contracts governed by foreign law.

A second issue of  Fed concern with respect to cross-border Title II resolution is that U.S. regulators cannot be certain how foreign authorities will react when the parent is put into the Title II proceeding. U.S. authorities, while they have been in discussion with their colleagues abroad to enable the coordination needed for a smooth cross-border resolution process, cannot always be certain of the circumstances under which host authorities may choose to take or be required to take actions such as unilateral ring-fencing that might disrupt the implementation of the single point of entry approach. He emphasized that U.S. regulators must continue to work with foreign regulators to iron out any issues ahead of time so that the resolution regime will work well for global, systemically important firms.