February 21st, 2018 by Nick Railton-Edwards
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Risk magazine reports that the Bulgarian Presidency of the Council of the EU[1] has suggested a reduction in the proposed “BRRD 2” pre-resolution stay period to two days, along with a recommendation that derivatives be included within the power’s scope. The Commission’s November 2017 proposal called for a pre-resolution power of moratorium, enabling national authorities to freeze a failing bank’s payment and delivery obligations for up to five days. The two-day compromise echoes the internationally agreed standard and represents the middle ground between the Council, who regard a 5 day period as a minimum, and a substantial group of MEPs arguing for the excision of all pre-resolution powers. Derivatives subject to netting were excluded from the originally-proposed pre-resolution stay, pending their stay upon entry into actual resolution. The Presidency proposal includes derivatives, presumably on the political grounds of not wishing to be seen to favour large financial institutions over ordinary depositors. Their inclusion raises the prospect that EU swaps may not be eligible for netting in the US, where the Federal Reserve requires third country stay regimes to be “substantially similar” to their own; the US regime limits  imposed stays to one day and does not entertain the concept of pre-resolution moratoria. Irrespective of the  dissimilarity between the actual US and Proposed EU regimes, the Federal Reserve will not issue an equivalence decision until BRRD 2 is implemented.

On balance, a pre-resolution mismatch may be less dissimilar than a potentially indefinite stay period during which counterpaties to a failing institution would not be able to enforce obligations and have no rights to terminate, close out or net any agreements. If the Federal Reserve were to decide that that the pre-resolution stay invalidates substantial similarity and derivatives remain included, US counterparties to EU firms will have to post collateral gross, rendering the vast majority of trans-Atlantic trades prohibitively expensive, further entrenching geographically-based liquidity fragmentation. Even absent the non-netting nuclear option, the Federal Reserve may elect to impose higher risk and capital weighting on trades with counterparties subject to the BRRD.  A March 2018 trilogue between the Parliament, Council and Commission is expected to finalise the proposed extent of stay powers. In order to avoid all too foreseen consequences, the EU must either drop pre-resolution altogether or reinstate the derivatives exemption and face the political fallout when the regulation is triggered and only depositors are affected.

[1] The Presidency is composed of six-monthly rotating member states and is distinct from the President

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