The January 1, 2019 compliance date for GSIBs to remediate their QFC with non-financial counterparties has come and gone, but many firms are still navigating the many moving parts of this requirement. The key to success is data management – creating a trusted product taxonomy that clearly defines what constitutes a QFC, and what the netting set is for each one. This is a massive undertaking, and will require changes to existing systems and processes as well as new ones.

The definition of a QFC is broad and expansive, encompassing swaps, repos and reverse repos, securities lending and borrowing transactions, commodity contracts, and forward agreements. To make matters more complicated, the rules provide that a QFC also may be an agreement between a non-financial institution and a GSIB, or a contract or arrangement between an incorporated financial entity and a GSIB. As a result, the number of QFCs that are in-scope is substantial, and remediation is challenging.

As a result, the QFC rules incentivize counterparty adherence to an industry “protocol” rather than bilateral amendments on a contract-by-contract basis. ISDA has prepared a variety of protocols that are designed to comply with the QFC rules, and the organization is working on additional ones. The benefits of a protocol-based approach include a reduction in administrative burden and a single point of contact for amending all in-scope QFCs. The disadvantage, however, is a loss of creditor protections that may be available through bilateral amendments.

GSIBs must decide which method of remediation is best for them, and the choice will depend on the terms of their existing in-scope agreements. Those terms are important, as the resolution rules incentivize a GSIB to opt in to the QFC rules through bilateral amendments that contain specific language on the Opt-In Requirement. In addition, the ISDA protocols contain certain dispensations from the rules (e.g., the Cross-Default Restriction) that may be unavailable to a GSIB through bilateral amendments.

As a general rule, the governing law and transfer restrictions in an in-scope QFC must be amended to comply with the rules. However, a covered QFC that does not have default rights related to affiliate bankruptcy proceedings or transfer restrictions on credit enhancements in the event of an affiliate bankruptcy proceeding is not subject to the transfer restriction and thus can remain unchanged.

As a result, the process of resolving QFCs is often a complicated one for GSIBs, and can involve numerous legal and regulatory discussions with their counterparties. In particular, because the resolution stay rules permit the FDIC to transfer a distressed GSIB’s QFCs to another financial institution during the brief period of time (typically only one business day) following an GSIB’s entry into receivership, contractual restrictions on transfers (“Transfer Restrictions”) must be removed from a QFC before it can be transferred during this temporary period. This is a difficult task, because such removal is often impossible without the consent of the relevant parties.