September 01, 2017
Statement on the Consideration of a Final Rule Restricting Qualified Financial Contracts by Governor Lael Brainard
Today's final rule, which is a part of a set of actions by the Board to address the "too-big-to-fail" problem, addresses one of the ways in which the severe distress or failure of a major financial firm can destabilize the U.S. financial system. As we witnessed during the last crisis, the failure of a large, interconnected financial company could cause severe damage to the U.S. financial system and, ultimately, to the economy as a whole. This final rule represents a further step to increase the resolvability and resilience of U.S. global systemically important banking organizations (GSIBs) and foreign GSIBs that operate in the United States. The Board has tailored this final rule to apply only to those banking organizations whose disorderly failure or severe distress would be likely to pose the greatest risk to U.S. financial stability: the U.S. GSIBs and the U.S. operations of foreign GSIBs.
The largest financial firms are interconnected with other financial firms through large volumes of financial contracts of various types, including derivatives transactions. The severe distress or failure of one entity within a large financial firm can trigger disruptive terminations of these qualified financial contracts, as the counterparties of both the failed entity and other entities within the same firm exercise their contractual rights to terminate the contracts and liquidate collateral. These terminations, especially if counterparties lose confidence in the GSIB quickly and in large numbers, can destabilize the financial system and potentially spark a financial crisis through several channels. They can destabilize the failed entity's otherwise solvent affiliates, causing them to fail and thereby destabilizing the entire organization, as well as potentially causing their counterparties to fail in a chain reaction that can ripple through the system. They also may result in fire sales of large volumes of financial assets, such as the collateral that secures the contracts, which can in turn weaken and cause stress for other firms by lowering the value of similar assets that they hold.
The final rule focuses on improving the orderly resolution of a GSIB by limiting the ability of the firm's counterparties to qualified financial contracts to terminate such contracts immediately upon entry of the GSIB or one of its affiliates into resolution. Accordingly, this rule bolsters financial stability by requiring that the QFCs of GSIBs do not trigger a disorderly and rapid failure that would complicate the firm's resolution and spread financial instability through the rest of the financial system.