Letters

Proposed Amendments to EU Law Affecting Global Financial Stability

Summary

SIFMA and The Clearing House (TCH) provide comments alerting the Financial Stability Oversight Council (FSOC) to a pending proposal to revise the European Union’s legal framework for bank resolution that would reduce financial stability in the United States and globally.  Given the FSOC’s duty to respond to “emerging threats to the stability of the United States financial system,” we request that the FSOC and its member agencies raise this issue at the Financial Stability Board and at the upcoming EU-U.S. regulatory dialogue.

PDF

Submitted To

Secretary of the Treasury and Members of the Financial Stability Oversight Council

Submitted By

SIFMA and The Clearing House

Date

31

October

2017

Excerpt

October 31, 2017

By Electronic Mail

The Hon. Steven T. Mnuchin
Chairman, Financial Stability Oversight Council
Secretary of the Treasury
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Re: Proposed amendments to EU law affecting global financial stability

Dear Secretary Mnuchin:

We are writing to alert the Financial Stability Oversight Council to a pending proposal to revise the European Union’s legal framework for bank resolution that would reduce financial stability in the United States and globally. Given the FSOC’s duty to respond to “emerging threats to the stability of the United States financial system,” we request that the FSOC and its member agencies raise this issue at the Financial Stability Board and at the upcoming EU-U.S. regulatory dialogue.

In a significant departure from globally established norms, the European Commission has proposed to amend the European Bank Recovery and Resolution Directive to give EU regulators the power to impose a prolonged form of single-institution “bank holiday.” Specifically, EU regulators would be authorized to suspend payment obligations of a bank to its counterparties and customers (including its depositors) for up to twelve business days, and possibly longer.1

While seemingly arcane, this proposed change, referred to as an extended “payments moratorium,” would create serious systemic and economic problems, both in crisis and in normal operations. The potential costs include a significant reduction in cross-border activity, a fragmentation of global financial markets and reduction in opportunities for market participants, including corporates and other end users, to hedge key exposures.

First, the potential for such a lengthy stay would incentivize creditors of EU banks to run even earlier, thereby making failure more likely and more sudden, and making it more likely that such a failure would have systemic consequences in the EU and beyond. Stays on deposit withdrawals, even if limited to wholesale deposits, would incentivize depositors to run at the first sign of trouble – an entirely rational reaction from a financial system dependent on daily access to funding and liquid markets. Further, the imposition of a moratorium at one EU bank (or even the fear thereof) would encourage counterparties to run from other EU banks at even the mere perception of a hint of trouble, thereby precipitating and accelerating precisely the types of liquidity stress and contagion that, even if localized to Europe, can pose substantial risks to global financial stability, including the financial stability of the United States.

Second, this standard would create a large and significant inconsistency between EU law and the law in the United States and the rest of the world, with serious systemic and economic consequences. Currently, the Bank Recovery and Resolution Directive allows authorities to suspend payment obligations of a bank in resolution for up to (but not more than) two business days and prevent counterparties from terminating contracts as a consequence. This current approach is consistent with U.S. law and global norms, including the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions.” The proposal would end this consistency.

In particular, the proposed changes to the EU resolution regime would give parties the opportunity – and an incentive – to opt out of the ISDA 2015 Universal Resolution Stay Protocol. This framework was carefully negotiated among regulators, banks and the buy side against the backdrop of a global agreement that stays on derivatives and other contracts should not exceed two days. This achieved a careful balance between the needs of authorities for flexibility in resolution and the needs of counterparties for certainty of either continued performance or timely close out. Breaking this international accord would undermine the effectiveness of a key post-crisis reform supporting the resolvability of internationally active banks—an arrangement the FSB hailed as an “important step towards completion of our comprehensive global reform agenda to end ‘too big to fail’” and which European regulators and resolution authorities helped to facilitate.2

This proposal, if adopted, would put derivatives dealers in an untenable position, as a derivative subject to a two-day moratorium cannot be considered as a risk management matter to be a hedge against a derivative subject to a far longer moratorium. A delay in payment on the EU derivative would leave the dealer in an unhedged position.

Continue Reading >

1 We understand that proposals are under consideration in Europe to shorten the moratorium period. However, even the proposals that limit the total suspension period to five business days would represent a significant divergence from global norms (more than doubling the current upper limit on the duration of stays) and raise the systemic risk concerns identified throughout this letter.

2 For additional information on how the proposed moratorium would undermine the ISDA resolution stay protocol, see ISDA’s paper Proposed Moratoria Under the BRRD: A Step Backwards in Efforts to End ‘Too Big To Fail’. Also of note, a separate ISDA paper, Challenges with Expanding BRRD Moratoria Powers, identifies the negative financial stability impacts of the proposal. Both papers are available at https://www2.isda.org/functional-areas/public-policy/financial-law-reform/.