On July 26, New York's Gov. Mario Cuomo signed into law a bill embodying the state Banking Department's program for supervision and liquidation of foreign bank branches and agencies.
These banking law amendments are of special interest to state-licensed offices of foreign banks. But the law is perhaps of even greater concern to those who deal with those offices, as it calls for rethinking some presuppositions about branch responsibilities.
Spur Was Committee Report
The amendments are largely an outgrowth of the 1992 Heimann Committee report which examined the adequacy of the state banking department's supervision of foreign bank offices in the aftermath of the BCCI and Banco Nazionale del Lavoro scandals.
The Heimann report largely gave the department a clean bill of health.
The more notable provisions in the amendments cure some statutory deficiencies the department perceived during its experience in closing BCCI's New York agency, one of its few litigated branch insolvencies in recent decades.
In that case, there were more than sufficient assets to satisfy claimants against the New York- licensed office.
Next time, the department realized, it might not be so lucky.
Prior Practice Formalized
The amendments in part embody what had previously been supervisory practice and understanding - and they very much reflect a supervisor's standpoint.
A number of the amendments impose or tighten regulatory requirements.
For instance, agencies are made subject to asset pledge and lending limit requirements previously applicable only to full branches.
Also, branches and agencies must keep records a identifying their and other offices' transactions and must notify the department of changes in control.
Section 606(4) of New York's banking law has long provided for a preference in a branch or agency liquidation for those who could demonstrate that their transaction was "had with" the New York office.
Now, however, the superintendent will not even consider a claim unless the underlying documentation specifies that it was with the New York office or if it appears on the branch's or agency's own books.
Those books and records must now indicate which transactions are for its own account and which are for other offices (certainly including "shell" branches) of the institution.
The banking superintendent's jurisdiction over assets is much broader: all property of the foreign bank that may be found within the state, whether designated as a New York office asset or not. On this issue, the law amendments.
Furthermore, the amendments impose a turnover requirement for all such assets and, subject to an important but limited exception to be discussed here, restricts setoff rights in connection with such a turnover to only New York liabilities of the branch or agency.
Other amendments are also inspired by the bankruptcy model, such as the superintendent's now express power to repudiate or assume executory contracts and an automatic stay.
The statutory approach amounts to treating the branch or agency as a separate bank on the liability side, but as a combined entity with other branches on the asset side.
The asymmetry of this approach can only be justified from the point of view of an especially aggressive insolvency receiver whose tasks are to gather assets, assess claims, and assure equality of treatment across the claims which pass muster.
Left in the cold will be those who dealt with the bank as a global enterprise, particularly if they held balances in New York accounts to the credit of non-New York offices of the insolvent bank.
These will be subject to turnover.
The banking department made a policy decision that the potential adverse effect of this rule on correspondent banking in New York is outweighed by the perceived need to protect those customers who implicitly sought the benefits of New York regulation by specifying "New York branch" in their documentation.
The setoff restriction is at the heart of the scheme, and probably its most controversial provision.
In England, for instance, setoff is compulsory in insolvency situations, and of course setoff is preserved (albeit with some restrictions) under the U.S. Bankruptcy Code.
The department at least partially heeded the concern of bankers who of late have been entering into so-called "global netting" agreements, either separately or as part of master swap agreements.
The amendments replicate, although perhaps not fully, the favored treatment of so-called "qualified financial contracts" - interest rate and currency swaps, caps, collars and various other derivative or hedging instruments - in liquidation under Federal banking laws, notably the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 and the Federal Deposit Insurance Corporation Improvement Act of 1991.
Broadly speaking, the purpose of all of these provisions is to validate the termination and netting provisions of qualified financial contracts and to carve them out of automatic stay, selective repudiation, and preference rules that would otherwise apply.
While netting is not the same as setoff, they are closely related.
Netting agreements have become prevalent risk-reduction tools in the industry and are receiving increasingly concrete encouragement by supervisors including most notably the Basel Committee on Bank Supervision.
Giving full effect to cross-border netting cuts a large hole in the "ring-fence" set up by the setoff restriction, however.
The outcome is a set of lengthy qualifications to the repudiation-of-contracts provision and setoff restriction in the case of qualified financial contracts, which were thrashed out between the department and a working group of the International Swap Dealers Association.
In these cases, the net termination amount payable in either direction is the lesser of the amount derived through operation of the applicable global netting agreement or a net amount calculated by reference to New York-only transactions.
A counterparty of a New York branch will benefit from this formula only if it has a greater loss on its transactions with the insolvent bank on a New York office-only basis than globally.
This provision can potentially diminish a counterparty's turnover requirement; it will not increase a claim.
Bank Deposits Issue
Notably, the New York Clearing House attempted (very late in the legislative process) to redefine "qualified financial contracts" to include bank deposits.
This was rejected by the department, but the issue may re-surface when regulations are drafted.
The banking department can be relied on to apply its liquidation law in the insolvency of a state-licensed branch or agency.
However, the application of New York law where there is federal involvement (such as the Comptroller as liquidator or the FDIC as receiver) is not well settled.
Since the federal insolvency regime for foreign banks adopted New York's "ring fence" approach as part of the Foreign Bank Supervision Enhancement Act in 1991, New York's influence will probably continue to be felt.
There will eventually occur a confrontation with bank supervisors overseas who believe (as was argued unsuccessfully in the BCCI case) that there should be a centralized, presumably head office-based insolvency procedure for international banks.
In the meantime, those who manage New York licensed branches and agencies, as well as those at other institutions who monitor and assess the risk level associated with dealing with them, have much to study.