As the financial crisis of 2008 demonstrated, when a large, global systemically important bank collapses, it can have reverberating effects well beyond the failed institution. To mitigate the potential for a destabilizing closeout of QFCs, the US banking agencies have implemented a series of regulations (Monticello Consulting has a helpful infographic). One such set of rules, the Qualified Financial Contract Resolution Stay Regulations (“QFC”), requires financial firms to amend their QFCs with each other to eliminate contractual terms that would prevent them from exercising certain default rights in the event of a G-SIB’s insolvency.

For buy-side counterparties, compliance with these regulations is crucial. Among other things, they must determine whether they are “financial counterparties,” which includes many types of agreements that are not customarily considered to be derivatives, such as multibranch master agreements (allowing different branches of a single entity to book transactions), investment management agreements, prime brokerage agreements, collateral agency agreements, trustee arrangements and escrow agreements. They must also consider the implications of ancillary provisions in these agreements that might cause them to fall within the definition of QFC, such as arbitration clauses and dispute resolution mechanisms.

In addition to determining their status, they must understand the amendment requirements, which require that all in-scope QFCs (including those that do not meet the definition of a QFC) be amended by Jan. 1, 2019. In particular, they must consider whether they are required to conform their QFCs with other covered entities, such as sovereigns, central banks and multilateral development banks, or with other non-U.S. community banks or non-GSIBs, or whether the GSIB’s regulatory authorities have granted them an exception to this requirement (the rules provide a safe harbor for these agreements).

The amended QFCs must be in place by that date in order for those parties to take advantage of the protections available under the QFC stay rules. To facilitate compliance, the International Swaps and Derivatives Association has published the ISDA 2018 U.S. Resolution Stay Protocol, which satisfies the amendment requirements of the QFC rules under the safe harbor. Adherence to the protocol automatically amends all in-scope agreements entered into by a party and any covered entity, assuming that the covered entity has also adhered to the Protocol.

In addition to the ISDA protocol, the QFC stay rules contain a number of other alternative methods for complying with their amendment requirements. However, those methods may not be appropriate for all circumstances, and buy-side participants should carefully weigh the pros and cons of each in light of their individual needs. For example, while the ISDA protocol provides a one-stop shop for a group of affiliated counterparties to amend their agreements to comply with the requirements of the QFC stay rules, it contains a cross-default restriction that may not be appropriate for all situations. Therefore, buy-side counterparties should seek advice from their advisers before deciding on an amendment method. QFC