Definition of “Default Right. As discussed above, a party to a QFC generally has a number of rights that it can exercise if its counterparty defaults on the QFC by failing to meet certain contractual obligations. These rights are generally, but not always, contractual in nature. One common default right is a setoff right: the right to reduce the total amount that the non-defaulting party must pay by the amount that its defaulting counterparty owes. A second common default right is the right to liquidate pledged collateral and use the proceeds to pay the defaulting party’s net obligation to the non- defaulting party. Other common rights include the ability to suspend or delay the non-defaulting party’s performance under the contract or to accelerate the obligations of the defaulting party. Finally, the non-defaulting party typically has the right to terminate the QFC, meaning that the parties would not make payments that would have been required under the QFC in the future. The phrase “default right” in the proposed rule is broadly defined to include these common rights as well as “any similar rights.”48 Additionally, the definition includes all such rights regardless of source, including rights existing under contract, statute, or common law. However, the proposed definition excludes two rights that are typically associated with the business-as-usual functioning of a QFC. First, same-day netting that occurs during the life of 48 See proposed rule § 382.1. the QFC in order to reduce the number and amount of payments each party owes the other is excluded from the definition of “default right.”49 Second, contractual margin requirements that arise solely from the change in the value of the collateral or the amount of an economic exposure are also excluded from the definition.50 The function of these exclusions is to leave such rights unaffected by the proposed rule. However, certain QFCs are also commonly subject to rights that would increase the amount of collateral or margin that the defaulting party (or a guarantor) must provide upon an event of default. The financial impact of such default rights on a covered entity could be similar to the impact of the liquidation and acceleration rights discussed above. Therefore, the proposed definition of “default right” includes such rights (with the exception discussed in the previous paragraph for margin requirements that depend solely on the value of collateral or the amount of an economic exposure).51 Finally, contractual rights to terminate w...
