NYSBL 618-a and 619
March 17, 2003
Kathleen A. Scott, Esq.
White & Case LLP
1155 Avenue of the Americas
New York, NY 10036-2787
Dear Ms. Scott:
By your letter dated April 24, 2001 to Deputy Superintendent and Counsel Kelsey, you requested the Banking Department's concurrence with your conclusion under the New York Banking Law that, in the context of a liquidation of a, New York state-licensed branch or agency of a foreign banking corporation by the Superintendent, a counterparty to a qualified financial contract ("QFC") with the foreign banking corporation being liquidated may realize on collateral in connection with the termination of the QFC due to such liquidation, regardless of whether that counterparty can file a claim with the Superintendent in liquidation. I regret the delay in responding. The Banking Department concurs with your conclusion.
You inquire on behalf of your client, Government Securities Clearing Corporation ("GSCC"), a securities clearing agency that provides automated trade comparison, netting and risk management and settlement services in order to assure orderly settlement of U.S. Government securities. Virtually all of the major U.S. Government market participants, mostly broker-dealers and banks, are members of GSCC (92 netting members, plus 27 members that utilize only trade comparison services).
Any member who wishes to take advantage of GSCC's netting, risk management, and settlement services must first sign a netting member agreement (the "Netting Member Agreement") pursuant to which the member agrees to abide by GSCC's rules and which permits GSCC to net all transactions conducted during a business day and present to each member a net position per security for the member to settle with GSCC. If the member wishes to engage in repurchase transactions with GSCC, the member also executes a repurchase netting agreement (the "Repurchase Netting Agreement"), which is an addendum to the Netting Member Agreement and obligates the member to abide by GSCC's rules pertaining to repurchase transactions.
GSCC's rules require the member to post collateral with GSCC as security for its obligations to GSCC. A certain portion of a member's collateral is required to be in the form of cash. Each member also enters into a clearing fund agreement (the "Clearing Fund Agreement"), which enables the member to post securities collateral or letters of credit with GSCC in addition to cash. The securities, letters of credit and cash collateral are held by GSCC or a bank acting as a custodian for GSCC. The member grants to GSCC a first priority perfected security interest in the securities and cash collateral. With respect to the letter of credit, the issuing bank issues the letter of credit with GSCC as the beneficiary. If the member does not satisfy its net settlement position with GSCC, GSCC is permitted to realize on the collateral in order to provide the liquidity necessary to close out the position and to cover any costs incurred by GSCC in the close-out process.
GSCC would like to permit foreign banking corporations that maintain New York state-licensed branches or agencies to become members, even if such foreign banking corporations do not use those branches or agencies to conduct QFC activities, and instead conduct such transactions with GSCC directly from their head offices or by using another non-New York branch or agency office. Currently, if a foreign banking corporation with a New York- licensed branch or agency approaches GSCC to become a member, GSCC permits only the New York-licensed branch or agency to become a member, although officials of the head office of the foreign banking corporation as a matter of course also sign the contract. This is done to ensure that GSCC may avail itself of the Banking Law provisions permitting a counterparty to a QFC with a New York branch or agency that is being liquidated to realize on collateral pledged in connection with such QFC. Your inquiry concerns GSCC's ability to similarly realize on such collateral pledged by another office of the foreign banking corporation, with which GSCC has entered into a QFC, in the event the Superintendent is liquidating the foreign banking corporation's New York branch or agency.
You note that the potential concern is with the interplay between Banking Law Sections 618-a(2)(b) and (c) and Section 618-a(2)(d) and whether the ability to realize on collateral provided for in Section 618-a(2)(d) is in any way contingent upon the ability to file a claim with the Superintendent for damages pursuant to Section 606(4), with such damages being calculated in accordance with Section 618-a(2)(b) or (c).
Banking Law Section 606(4) provides that, upon the Superintendent's taking possession of a foreign banking corporation's New York-licensed branch or agency, title to all business and property in New York State vests by operation of law in the Superintendent. "Business and property in this state" of the foreign banking corporation includes title to all the assets of the particular branch or agency, wherever located, as well as title to the assets of the foreign banking corporation located in New York, whether or not appearing in the books of the New York branch or agency. A claims process is instituted and those persons who have had transactions with the New York state-licensed branch or agency being liquidated may present their claims for payment and only the claims of creditors arising out of their transactions with the branch or agency shall be accepted out of the estate administered by the Superintendent.
Pursuant to Section 615(2) of the Banking Law, the Superintendent may make written demand upon each person who holds assets of the banking corporation being liquidated to turn them over to the Superintendent. However, such demand is inapplicable in the case of a secured creditor with a properly perfected security interest to retain collateral. Under Section 619(d)(1) of the Banking Law, parties holding collateral representing assets of the banking organization being liquidated generally are automatically stayed from being able to realize on such lien. However, an exception under Section 619(1)(d)(2) exists permitting a secured creditor to a QFC to retain and apply such collateral in accordance with Section 618-a(2)(d).1
Application of New York Banking Law Provisions to GSCC Netting and Settlement Operations
After two netting parties decide on a particular trade, GSCC compares, nets, novates and guarantees the settlement of the trade. Novation is the process by which GSCC becomes the counterparty to each side of the trade; that is, it provides its own commitment to purchase or deliver securities (or enter into repurchase transactions) in order to ensure that the trade originally entered into between the two counterparties is settled in an orderly manner.
GSCC views both the individual transactions under the Netting Member Agreement (and the Repurchase Netting Agreement, if applicable), as individual QFCs and the Netting Member Agreement and the Repurchase Netting Agreement and the GSCC Rules as master agreements that are also QFCs. GSCC Rule 4 and the Clearing Fund Agreement are viewed by GSCC as security arrangements "related to" a QFC. GSCC believes the individual transactions fall within the definition of QFC because they are securities contracts and in some cases also repurchase agreements.
GSCC's characterization of these contracts as QFCs within the meaning of the Banking Law would appear to be accurate. Banking Law Section 618-a(e) defines a "qualified financial contract" as:
"any securities contract, commodity contract, forward contract (including spot and forward foreign exchange), repurchase agreement, swap agreement, and any similar agreement, any option to enter into any such agreement including any combination of the foregoing, and any master agreement for such agreements (such master agreement, together with all
If, after netting, it is determined that the counterparty is liable to the foreign banking corporation as a whole, then the Superintendent may recover the lesser of : (i) "the global net payment entitlement" (i.e. the amount, if any, owed by a party to the foreign banking corporation as a whole after giving effect to the netting provisions of a QFC with respect to all transactions subject to netting under such QFC); and (ii) "the branch/agency net payment entitlement (i.e. the amount, if any, that would have been owed by a party to the foreign banking corporation after netting only those transactions entered into by the branch or agency and such party under the QFC). The liability of the party to the Superintendent would be further reduced by (1) any amount otherwise paid to or received by the Superintendent or any other liquidator or receiver of the foreign banking corporation in respect of the global net payment entitlement pursuant to such QFC which, if added to the liability of the party, would exceed the global net payment entitlement; and (2) the fair market value or the amount of any proceeds of collateral that secures and has been applied to satisfy the obligation of the party pursuant to the QFC to the foreign banking corporation.
supplements thereto, shall be treated as one QFC), provided that such contract, option or agreement, or combination of contracts, options or agreements, is reflected in the books or records of the banking organization or a party provides documentary evidence of such agreement."
The agreements into which GSCC enters all relate to government securities transactions and are documented in GSCC's books, accounts and records.
The core of your inquiry is whether GSCC would be permitted to realize on collateral it held in relation to QFCs, in accordance with Banking Law Section 618-a(2)(d), in a scenario in which GSCC's counterparty was a non-New York office of the foreign banking corporation and thus GSCC would have no standing as a creditor of the New York branch or agency in a liquidation.
We concur with your view that Section 618-a(2)(d) is intended to benefit a broader group of persons than creditors of the New York branch or agency, and GSCC would be permitted to realize, pursuant to the terms of that section, on collateral held in relation to a QFC entered with a non-New York office of the foreign banking corporation. The 1999 amendments and the related legislative history of that provision make this clear. In 1999, Section 618-a(2)(d) was amended as follows:
"A party to a qualified financial contract with [the branch or agency of the] a foreign banking corporation, the branch or agency of which the superintendent is liquidating, which party has a perfected security interest in collateral, or other valid lien or security interest in collateral enforceable against third parties pursuant to a security arrangement related to such qualified financial contract, may retain all such collateral and upon repudiation of that qualified financial contract, or in connection with the termination or liquidation of that qualified financial contract in accordance with its terms thereof, apply such collateral in satisfaction of any claims secured by the collateral, provided that the total amount so applied to such claims shall in no event exceed the global net payment obligation, if any." (Deletions are bracketed; additions are underlined).
The legislative history of this amendment makes clear that the amendment was intended to broaden the benefits of that section to apply not only to holders of collateral under a QFC with the New York branch or agency itself, but also to holders of collateral who entered into a QFC with any other office of the foreign banking corporation, the New York branch or agency of which is in liquidation. The amendment sought to remove the uncertainty that such collateral relating to QFC with a non-New York office of the foreign banking corporation would be treated as property of the foreign banking corporation, title to which would vest in the Superintendent upon possession of the New York branch or agency pursuant to Banking Law Section 606(4). (See New York State Senate Memorandum in Support of Chapter 84 of the Laws of 1999 ("Memorandum in Support"), McKinney's 1999 Session Laws of New York, pp. 1557-1558).
It is useful to quote at length from the Memorandum in Support:
"This amendment will promote increased certainty, security and efficiency in the financial markets by helping to preserve the effectiveness and value of netting arrangements and clearinghouses. "Netting" arrangements are increasingly being used to settle financial transactions between parties. Corporations often use master agreements to provide for the settlement of numerous contracts, thereby helping to limit the risk of any particular transaction. These arrangements frequently involve transactions entered into by several different offices of a particular party. Furthermore, clearinghouses have been established to hold, net and/or settle such transactions. These clearinghouse arrangements are intended to help reduce risk in the event that a financial institution fails. In order to limit the impact and repercussions of a failure, it is important to be able to quickly settle outstanding transactions. Therefore, it is crucial that parties be able to access and apply the collateral posted by the financial institution. This helps maintain the integrity of the system and ensures that the clearinghouse is able to meet obligations and settle transactions.
"Chapter 496 of 1993 addressed this issue by allowing counterparties to retain and apply the collateral of the New York-licensed branch or agency that is being liquidated. However, the same issues and concerns arise in regard to the collateral posted by a non-New York office which is a party to the qualified financial contract. Because any collateral of the foreign banking corporation which is held in New York, but which was pledged by an office located outside New York, would currently be subject to the State's automatic stay on assets, the current law may interfere with and disrupt the netting and settlement process, and could adversely affect a creditor's liquidity. This bill would address this potential problem by expanding the 1993 law to provide that, where any office of the foreign banking corporation (including a New York branch or agency) is a party to a qualified financial contract, and where its licensed branch or agency is being liquidated, a counterparty to a contract may apply the collateral of the foreign bank.
"This amendment will also help preserve New York's role as a location for custodial institutions and financial clearinghouses. Under current law, parties to a qualified financial contract with a non-New York office of a foreign banking corporation may face the problem of having their New York based collateral held until a liquidation is resolved. Therefore, these parties may be reluctant to maintain in New York any collateral which was pledged by a non New York office of the foreign bank; instead, they may seek to avoid this problem by using a custodian located outside New York. As a result, the current law places New York-based custodial institutions at a disadvantage, and may harm New York's position as a financial center. The 1993 law, which recognized and addressed this issue as it relates to collateral of New York-licensed foreign bank branches and agencies, has helped ensure New York's attractiveness for maintaining collateral posted by these institutions. This bill would expand the law to also ensure New York's attractiveness for maintaining collateral for non-New York offices of such foreign banks."
Accordingly, we concur with your conclusion in the scenario you described that the ability to file a claim and the ability to realize on collateral posted in connection with a QFC are independent concepts under the Banking Law, and thus the ability to realize on such collateral is not contingent on the ability to file a claim for damages based upon a transaction with the New York state-licensed branch or agency being liquidated.
I trust that this is helpful.
1 Sections 618-a(2)(a), (b) and (c) relate to the calculation of damages for repudiated or terminated QFCs. The Banking Law provides that the Superintendent shall not assume or repudiate a QFC that the branch or agency has entered into which is subject to a multi-branch netting agreement or arrangement that provides for netting present or future payment obligations or payment entitlements (including termination or close-out values relating to the obligations or entitlements) among the parties to the contract and agreement or arrangement.
In general, the liability of the Superintendent to any party to a QFC subject to netting arrangements upon repudiation or in connection with the termination or liquidation of such QFC shall be calculated as of the date of repudiation or the date of termination of such QFC and shall be limited to the lesser of: (i) "the global net payment obligation" (i.e. the amount, if any, owed by a foreign banking corporation as a whole to a party after giving effect to the netting provision of a QFC with respect to all transactions subject to netting under such QFC) and (ii) "the branch/agency net payment obligation" (i.e. the amount, if any, that would have been owed by the foreign banking corporation to a party after netting only those transactions entered into by the branch or agency and such party under such QFC). The liability of the Superintendent would be further reduced by (1) any amount otherwise paid to or received by the party in respect of the global net payment obligation pursuant to the QFC which, if added to the Superintendent's liability, would exceed the global net payment obligation; and (2) the fair market value or amount of any proceeds of collateral that secures and has been applied to satisfy the obligations of the foreign banking corporation pursuant to such QFC to the party. (back)