[Editor’s Note: The following post is authored by Davis Polk & Wardwell LLP]
The Federal Reserve has issued an interim final rule clarifying the treatment of uninsured U.S. branches and agencies of foreign banks under Section 716 of the Dodd-Frank Act (“Swaps Pushout Rule”). The interim final rule clarifies that, for purposes of the Swaps Pushout Rule, all uninsured U.S. branches and agencies of foreign banks are treated as insured depository institutions. Accordingly, a foreign bank swap dealer’s uninsured U.S. branch or agency will benefit from the Swaps Pushout Rule’s exemptions, transition period and grandfathering provisions to the same extent as an insured depository institution. The interim final rule also establishes a process for uninsured state branches and agencies of foreign banks and state member banks to apply to the Federal Reserve for a transition period from the July 16, 2013 effective date of the Swaps Pushout Rule. The interim final rule became effective on June 5, 2013, and comments on the rule are due on August 4, 2013.
Background on the Swaps Pushout Rule
What Does the Swaps Pushout Rule Do? By its terms, the Swaps Pushout Rule prohibits any “federal assistance” from being provided to “swaps entities,” including registered swap dealers, security-based swap dealers, major swap participants and major security-based swap participants.1 “Federal assistance” includes FDIC deposit insurance and access to the Federal Reserve’s discount window. This means, for example, that a bank that registers as a swap dealer2 will not be eligible for deposit insurance or access to the Federal Reserve’s discount window unless the bank “pushes out” its swap activities to non-bank affiliates that are not eligible for deposit insurance or access to the Federal Reserve’s discount window, or ceases to engage in such swaps activities altogether, subject to any applicable exemption, transition period or grandfathering provision.
Exemptions, Transition Period and Grandfathering Provisions. The statutory text of the Swaps Pushout Rule contains an exemption that allows an “insured depository institution” to engage in swaps used to hedge or mitigate risk and swaps involving rates or national bank-eligible assets (e.g., interest rate swaps and swaps that reference currencies, bullion metals, loans or bank-eligible debt securities), other than uncleared credit default swaps. The Swaps Pushout Rule also authorizes the appropriate U.S. banking agency, after consulting with the CFTC and the SEC, to provide an “insured depository institution” a transition period of up to two years, which can be extended by one additional year, to cease any non-exempt swap activities. In addition, there is a grandfathering provision providing that the Swaps Pushout Rule will only apply to swaps entered into by an “insured depository institution” after the end of the transition period.
Federal Reserve’s Clarification for Foreign Bank Swap Dealers
Prior to the Federal Reserve’s interim final rule, there was significant uncertainty regarding the impact of the Swaps Pushout Rule on foreign banks. For example, it was unclear whether uninsured U.S. branches and agencies of foreign bank swap dealers would benefit from the Swaps Pushout Rule’s exemptions, transition period and grandfathering provisions, which, on the face of the statute, applied only to “insured depository institutions.” A significant number of foreign banks that have registered or will soon register as swaps entities operate branches or agencies in the United States that are not eligible for deposit insurance, but that have access to the Federal Reserve’s discount window.3
The Federal Reserve’s interim final rule clarifies that all uninsured U.S. branches and agencies of foreign banks, i.e., both federally-licensed and state-licensed branches and agencies, are treated as insured depository institutions for purposes of the Swaps Pushout Rule. Accordingly, an uninsured U.S. branch or agency of a foreign bank swap dealer will benefit from the Swaps Pushout Rule’s exemptions, transition period and grandfathering provisions to the same extent as an insured depository institution.
The Federal Reserve provided a number of justifications for its interpretive resolution of the ambiguity surrounding the term “insured depository institution” as used in the Swaps Pushout Rule. It noted that for certain purposes of the Federal Deposit Insurance Act, the term “insured depository institution” is defined to include an uninsured U.S. branch or agency of a foreign bank. The Federal Reserve also pointed out that both uninsured and insured U.S. branches and agencies of foreign banks may receive discount window advances on the same terms and conditions that apply to insured state member banks, which means that uninsured U.S. branches and agencies of foreign banks are treated as insured member banks for purposes of the only federal assistance that causes uninsured U.S. branches and agencies of foreign banks to be affected by the Swaps Pushout Rule.
According to the Federal Reserve, treating uninsured U.S. branches and agencies as insured depository institutions furthers the objectives of Title VII of the Dodd-Frank Act by providing sufficient opportunity for uninsured U.S. branches and agencies to conform or cease their swaps activities in an orderly manner and to continue the same risk-mitigating hedging and other activities permitted for insured depository institutions. The Federal Reserve also noted that its interim final rule is consistent with the legislative history of the Swaps Pushout Rule, which suggests that Congress intended to treat uninsured branches and agencies as insured depository institutions.4
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