Companies that the Financial Stability Oversight Council (FSOC) believes may be subject to FDIC receivership under the Orderly Liquidation Authority contained in Title II of the Dodd-Frank Act, and certain of their affiliates, are now subject to recordkeeping requirements related to their “qualified financial contracts”1 (QFCs). Under Title II, in extraordinary circumstances, certain nonbank financial companies may be designated by the Secretary of the Treasury for resolution by the FDIC, under the same type of provisions that apply to the receivership of an insured depository institution, rather than the otherwise applicable insolvency regime (such as the Bankruptcy Code). A wide range of nonbank financial companies – including investment companies and investment advisers – that meet certain criteria are now subject to these new recordkeeping requirements (Rule).2 The first step in this new recordkeeping regime for an entity subject to the Rule is to identify, by March 30, 2017, a point of contact who will be responsible for QFC recordkeeping in compliance with the Rule.
Entities Subject to the Rule
The Rule requires entities that are deemed to be a “records entity” to maintain certain records regarding their QFCs. The Rule defines a “records entity” as a company that is:
- incorporated or organized under the laws of the United States;
- predominantly engaged in activities determined by the Federal Reserve Board (FRB) to be financial in nature or incidental thereto;3
- a party to an open QFC; and
- one of the following entities:
- a nonbank designated by FSOC as a systemically important financial institution (SIFI);
- a systemically important financial market utility (FMU);
- an entity that is identified as a global systemically important bank holding company (GSIB) under FRB regulations;4 or
- an entity with at least $50 billion in total consolidated assets and either: (i) at least $250 billion in total gross notional derivatives or (ii) at least $3.5 billion of derivatives liabilities.
In addition, the term “records entity” applies to all entities that are consolidated entities within a corporate group in which at least one entity is deemed to be a records entity.
The preamble to the Rule notes that records entities may include the following types of financial companies: bank holding companies; broker-dealers; investment advisers; investment companies; swap dealers; security-based swap dealers; major swap participants; major security-based swap participants; derivatives clearing organizations; and clearing agencies.
Investment Companies and Investment Advisers as Records Entities
The preamble to the Rule makes clear that investment companies and investment advisers may be covered by the Rule. For example, an investment company or investment adviser might be subject to the Rule if the entity meets the assets and either of the activities tests.
In this regard, total assets are generally measured as the total assets reported on the audited consolidated statement of financial condition submitted to the relevant entity’s primary financial regulator.5 For registered investment companies (funds), total assets would be the total assets as reported on the fund’s most recent financial statements as filed on Form N-CSR. Importantly, each series of a series fund (as defined in Rule 18f-2 under the Investment Company Act of 1940) will be deemed to be a separate financial company.6 In addition, funds will not be considered affiliates of an investment adviser, and they will not be considered to be affiliates of other funds managed by the investment adviser, solely by virtue of sharing the same investment adviser.7 Investment advisers would calculate total assets using their audited financials for the most recent fiscal year.8
As noted above, under the $50 billion total asset threshold test, a financial company will only be a records entity if it also meets either the gross notional derivatives exposure threshold or the derivatives liabilities threshold.9 Notably, with respect to determining who is a party to a QFC, the preamble to the Rule states that “an entity will not be a party to a QFC for purposes of the [Rule]” if it is only a party to such QFC for the limited purposes of providing a representation.”
The Rule does not apply to insurance companies,10 insured depository institutions (IDIs),11 subsidiaries of IDIs that are not a functionally-regulated subsidiary or a security-based swap dealer or major swap participant; and Fannie Mae, Freddie Mac and the Federal Home Loan Banks.12 Records entities with 50 or fewer open QFCs are only required to maintain documents that govern QFC transactions between the records entity and its counterparties.
The Rule allows an entity to apply in writing to the Treasury Department, FDIC, and the records entity’s primary financial regulatory agency or agencies, for an exemption from the recordkeeping requirement. The requesting entity must provide information as to: (i) the types of records for which the exemption is sought; (ii) the size, risk, complexity, leverage, frequency, dollar amount, and interconnectedness to the financial system of any QFCs; and (iii) reasons why granting the exemption will not harm the FDIC’s ability as receiver.
Pursuant to the Rule, a records entity is required to maintain certain QFC-related records, and to provide them to the FDIC within 24 hours following request, when the FDIC is acting as a receiver pursuant to its orderly liquidation authority under Title II. The records must include specific data and information helpful to the FDIC in resolution, including: position-level data; legal agreements (including master netting agreements); outlines of the records entity’s and counterparties’ organizations; QFC-related vendor agreements; and all documents that govern the QFC transactions.
The Rule also requires that records be kept electronically according to the tables provided in Appendix A to the Rule. This also requires compatibility with the FDIC’s systems. If the records are maintained by an affiliate or a service provider, the records entity must also keep its own records in order to ensure their maintenance.
Additionally, top-tier financial companies13 must compile data in a format that allows for aggregation and disaggregation by the records entity and by counterparties for all records entities in its corporate group that are consolidated by or with such top-tier financial company.
Treatment of QFCs in Title II Resolution
The FDIC, in its capacity as receiver14 for a nonbank financial company under Title II, has three options with respect to dealing with QFCs to which the failed institution is a party:
- The FDIC may transfer the QFCs to another financial institution that is not in default.15
- The FDIC may disaffirm or repudiate a QFC within a reasonable period of time if the FDIC determines the contract is burdensome and, in that instance, must pay compensatory damages.
- The FDIC may retain a QFC in the receivership, which would allow the counterparty to terminate the QFC.16
A counterparty to a QFC is subject to a stay until the earlier of: (i) notification by the FDIC to the counterparty regarding the action to be taken with respect to the counterparty’s QFCs; or (ii) 5:00 p.m. (Eastern) on the next business day after the FDIC is appointed receiver. In light of this short timeframe, the FSOC made a determination that “it is necessary and appropriate for the FDIC to have access to detailed, standardized records form the financial companies that potentially would be the most likely to be considered for orderly liquidation under Title II.”17 The Rule is intended to aid the FDIC as receiver in resolving failed institutions while protecting counterparties to QFCs as well as the financial system.
Point of Contact Requirement
Records entities and top-tier financial companies must provide in writing, to their primary financial regulator and the FDIC, a point of contact responsible for the required QFC recordkeeping. Changes to that point of contact must be submitted within 30 days. As noted above, records entities must be in compliance with this requirement by March 30, 2017.
The Rule is effective as of December 30, 2016. In addition to the point of contact compliance date noted above, the compliance deadlines for the recordkeeping requirements are staggered as follows, according to total consolidated assets of the records entity:
Total Consolidated Assets of Records Entity as of December 30, 2016/Required Compliance Date from Date of Becoming a Records Entity
- Equal to or greater than $1 trillion/540 days
- Equal to or greater than $500 billion and less than $1 trillion/2 years
- Equal to or greater than $250 billion and less than $500 billion/3 years
- Less than $250 billion/4 years
For entities that become records entities after December 30, 2016, the point of contact information must be provided within 90 days of becoming a records entity. A new records entity must comply with all recordkeeping requirements for the longer of: (i) 540 days; or (ii) the end of any unexpired initial compliance period. The Rule allows records entities to apply for an extension of time, provided the request is submitted in writing at least 30 days prior to the compliance deadline.
For entities that no longer individually qualify as a records entity after the initial compliance period, the former records entity may cease QFC recordkeeping immediately, unless such entity otherwise qualifies as a records entity as a member of a corporate group.
1) A QFC is a generally a transaction that meets the definitions of securities contract, commodities contract, forward contract, repurchase agreement or swap agreement contained in Title II. 12 U.S.C. § 5390(c)(8)(D)(ii)-(vi).
2) Qualified Financial Contracts Recordkeeping Related to Orderly Liquidation Authority, Final Rule, 81 Fed. Reg. 75624 (Oct. 31, 2016).
3) 12 U.S.C. § 5381(a)(11) (citing 12 U.S.C. § 1843(k)(4)).
4) 12 C.F.R. Part 217. The FRB, the Office of the Comptroller of the Currency and the FDIC have proposed regulations that would impact parties to a QFC with a global systemically important banking organization or an affiliate thereof. See Dechert OnPoint, Proposed U.S. Federal Reserve Board Rule’s Impact on Buy-Side Remedies in QFCs with Global Systemically Important Banking Organizations and their Affiliates, June 2016.
5) If no financial statements are required to be submitted to the entity’s primary financial regulator, then the total assets are as shown on the consolidated balance sheet of the entity for the most recently completed fiscal year prepared in accordance with U.S. generally accepted accounting principles (GAAP) or other applicable accounting standards.
6) 81 Fed. Reg. at 75631.
8) Note that certain investment advisers must include their audited balance sheet for the most recent fiscal year in their brochure as required by Part 2A Item 18 of Form ADV. However, this requirement only affects a small minority of investment advisers. Generally, most investment advisers are not required to maintain audited financials under the Investment Advisers Act of 1940.
9) Gross notional derivatives outstanding refers to the total value of all money associated with the derivatives transactions at their respective spot price. Derivatives liabilities are defined in the Rule as “the fair value of derivative instruments in a negative position that are outstanding as of the end of the most recent fiscal year as recognized and measured in accordance with GAAP or other applicable accounting standards, taking into account the effects of master netting agreements and cash collateral held with the same counterparty on a net basis to the extent reflected on the financial company's financial statements.” See 31 C.F.R. §148.1(e) and (s).
10) Although an insurance company may be resolved under Title II, such a resolution will be conducted under state law. 12 U.S.C. § 5383(e).
11) Since 2008, the FDIC has had a QFC recordkeeping requirement that applies to IDIs that are deemed to be in a troubled condition. 12 C.F.R. Part 371. The FDIC has proposed to update its regulation to coordinate with the FSOC’s QFC Rule. See Recordkeeping Requirements for Qualified Financial Contracts; Notice of Proposed Rulemaking, 81 Fed. Reg. 95496 (Dec. 28, 2016).
12) These entities are not included under the definition of “financial company.”
13) “Top-tier financial company” means a financial company that is a member of a corporate group consisting of multiple records entities and that is not itself controlled by another financial company. 31 C.F.R. § 148.2(q).
14) Where a broker-dealer is placed in a Title II receivership, that receivership would be conducted by Securities Investor Protection Corporation generally under the terms of the Securities Investor Protection Act of 1970, but subject to Title II QFC provisions. 12 U.S.C. § 5385(b)(4). See Dechert OnPoint, SEC and FDIC Propose Dodd-Frank Broker-Dealer Resolution Rules, April 2016.
15) If the FDIC transfers the QFCs to another institution, then the counterparty to the transferred QFCs will not be able to exercise any rights available to such counterparty under the QFC governing documents solely based on or incidental to: (i) the appointment of the FDIC as receiver; or (ii) the insolvency or financial condition of the institution for which the FDIC is appointed receiver.
16) 81 Fed. Reg. at 75624-5.
17) Id. at 75625.