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Fed Proposes Rule to Shield Banks From Hedge Funds

May 3, 2016, 6:19 PM UTC
Yellen Testifies At Joint Economic Committee Hearing On Economic Outlook
Mark Wilson—Getty Images

Big U.S. banks will have greater protection from hedge funds in a future financial crisis under a Federal Reserve proposal released on Tuesday that would require some investors to wait 48 hours before cutting ties with failing lenders.

The two-day pause is meant to prevent a chaotic unraveling of investments like what was seen during the 2008 financial crisis and failure of Lehman Brothers Holdings Inc.

At that time, desperate investors tried to void ties to Lehman after it sought bankruptcy protection, helping to spread panic in global financial markets.

The scene of derivatives investors desperate to unwind contracts could spur a modern-day run on a bank, Federal Reserve Chair Janet Yellen said on Tuesday, leading to “asset fire sales that may consume many firms.”

Tuesday’s proposal envisions a cooling-off period that may give banks time to transfer securities like derivatives to a healthy bank before bankruptcy, Yellen said.

Derivatives investors would have to acknowledge the 48-hour cooling offer period in new financial contracts and the rule could come into force next year, according to the proposal.

Existing financial contracts would also be captured if the investment fund and bank continue to do business once the rule is in place, according to Federal Reserve officials.

Wall Street has until Aug. 5 to comment on the plan.

The new rule was envisioned as part of the Dodd Frank reform legislation and has backing from the Financial Stability Board, a global standard-setting panel for financial markets.

The Managed Funds Association, a voice for the hedge fund industry, opposes the Fed’s move and argues that it strips investors of rights. (Reporting by Patrick Rucker; Editing by James Dalgleish)