On December 17, 2014, President Obama signed into law a federal omnibus spending bill that amends Section 716 of the Dodd-Frank Act, known as the Swaps Pushout Rule, a key component of Title VII swaps regulation (see Practice Note, The Dodd-Frank Act: Swaps Pushout Rule). The rule will now apply only to a narrow range of swaps transactions, related to asset-backed securities (ABS).

The Swaps Pushout Rule, enacted under Section 716 of the Dodd-Frank Act, requires that banks push their swaps activity out of any units that are eligible for federal deposit insurance. Section 716 enables banks to remain eligible for federal assistance only if they push certain derivatives activities out of their FDIC-insured depository institution (IDI) subsidiaries and into separately capitalized affiliates. The rationale behind the rule was to make IDIs move certain swaps operations viewed as risky out of the bank's depository unit so that they do not threaten customer bank deposits.

The spending bill dramatically reduces the scope of the swaps pushout rule, eliminates this pending restriction for most types of derivatives. The amended pushout rule permits banks to continue to engage generally in market-making swaps activities within their IDI units. The rule has been subject to delays, but is scheduled to take effect for some banks on July 16, 2015 (see Legal Update, Major Banks Granted Two Year Extension under Pushout Rule and Swaps and Derivatives Compliance Calendar).

According to a release from Davis Polk & Wardwell LLP, IDIs and US branches and agencies of foreign banks that are swap dealers or security-based swap dealers (collectively, Covered Depository Institutions or CDIs) will still be required to push out certain swaps that are based on ABS or a group or index primarily comprised of ABS (collectively, ABS Swaps). The amendment refers to these swaps as "structured finance swaps."

A CDI may nonetheless enter into ABS Swaps if the swaps are either:

According to Davis Polk, until prudential regulators jointly adopt such rules permitting ABS Swaps, the scope of the Pushout Rule will be unclear.

The original pushout provision permitted an IDI to engage in swaps referencing assets permissible for investment by a national bank, which included many types of ABS. The amendment eliminates that exemption, so that some of those ABS Swaps now may need to be pushed out.

The amendment codifies the Federal Reserve’s rule that uninsured branches and agencies of foreign banks are entitled to the same exceptions as IDIs under Section 716. It confirms that uninsured branches and agencies of foreign banks do not need to push out swaps to an affiliate, except for certain ABS Swaps.

According to the Davis Polk release, the following types of swaps are now permissible for an IDI under the rule:

According to the Davis Polk release, ABS Swaps are now impermissible for an IDI under the rule, unless they are either:

(Note that the Davis Polk release includes a helpful blackline comparing original Dodd-Frank Section 716 with amended Section 716.)

Congressional Democrats, among others, have expressed concern that the amendment:

It is worth noting that it appears that the types of CDS that caused issues for AIG during the crisis would likely still be required to be pushed out of the CDI unit because those swaps were CDS written with CDOs as the reference obligation. These swaps would therefore likely be considered ABS Swaps (structured finance swaps) under the amendment.

The measure is nonetheless being viewed as a victory for Wall Street banks, which viewed as excessively costly the structural changes in their business that would have been needed to comply with the original rule. Indications are that bank lobby groups intend to pursue further Dodd-Frank rollbacks once Republicans assume a majority of both houses of congress in 2015.

While this rollback of the rule has been widely criticized, the Harvard Business Law Review recently published an article suggesting that the Swaps Pushout Rule would not have been an adequate anti-bailout measure regardless. As originally written, the Swaps Pushout Rule would have successfully prevented insured depository institutions from entering into only certain types of swaps contracts, and only to a certain extent. The rule would not have extended to interest rate swaps and foreign exchange swaps, which represent the majority of the market value of systemically important bank holding companies.

Because the rule would have merely pushed the remainder of a CDI's swaps out of the bank's IDI subsidiaries and into other affiliated entities under the same ultimate parent, the rule would have been ineffective in protecting against future bailouts. If ultimately a systemically important CDI is in need of a taxpayer bailout due to insolvency, it does not matter which subsidiary has booked its swaps, similar to the swaps "de-guaranty" issue (see Legal Update, CFTC to Close Dodd-Frank Swaps "De-guaranty" Loophole).