Federal Reserve targets big bank customers

Hedge funds, insurers, and other companies that do business with Wall Street megabanks will pay a price for regulators’ efforts to ensure any future collapse of a giant lender doesn’t tank the entire financial system.

The Federal Reserve is set to propose so-called stays on derivatives and other contracts that would prevent counterparties from immediately pulling collateral from a failed bank.

The plan is meant to give authorities ample time to unwind a firm, hopefully heading off the frantic contagion that spread through markets when Lehman Brothers toppled in 2008.

The curbs would apply to any new contract signed by eight of the biggest and most complex US bank holding companies and the US arms of major foreign banks.

Fed governor Daniel Tarullo said the proposal is “another step forward in our efforts to make financial firms resolvable without either injecting public capital or endangering the overall stability of the financial system.”

Industry groups representing firms such as Citadel, BlackRock and MetLife have resisted efforts to rewrite financial contracts, arguing it abuses investors’ rights and could make things worse by encouraging trading partners to try to pull away from a bank at the first whiff of trouble.

But asset managers and insurers would face a tough task in persuading the Fed to change course.

Banks have already agreed to impose delays on deals with other lenders, and regulators insist the plan is key to their strategies for avoiding another crisis.

The Fed’s proposal is part of a global effort announced by the Financial Stability Board two years ago to set the contract stays in stone through regulation.

While authorities can’t require money managers, pension funds, and insurers to rewrite contracts, the regulators can force their hands.

The Fed’s rule would prevent banks from doing business with firms that won’t agree to keep non-cleared derivatives, repos and securities-lending contracts in place for at least 48 hours should one party to the contract collapse.

If a hedge fund wants to keep doing deals with banks, it would have to toe the line.

“This wasn’t the industry’s idea; this was the regulators’ idea,” Ken Bentsen, head of the Securities Industry and Financial Markets Association, said.

While he said he recognises agencies see the rule as necessary to take down faltering banks, the “biggest problem” would be if it sweeps in existing contracts rather than just targeting new ones.

Before they can finalise the rule, which comes with a one-year implementation period, US regulators must seek public comment on the proposal. The Fed will accept feedback until August 5.

More than a dozen global banking giants including JPMorgan Chase and HSBC first agreed to start revising financial contracts in 2014, with the initial accord covering an estimated 90% of the derivatives market.

Last year, banks expanded the agreement on contracts with each other.