Regulation EE Explained: Netting Eligibility for Financial Institutions

Regulation EE, introduced by the Federal Reserve in 1994, lets financial institutions settle obligations at net value, boosting efficiency and reducing risk. In 2019, the definition of financial institutions was expanded to include more entities. The regulation sets clear rules to determine if a company qualifies as a financial institution.

Basics

The U.S. Federal Reserve Board established Regulation EE, which is also known as netting eligibility. It broadens the definition of "financial institution" under the FDIC Improvement Act of 1991. This expansion includes financial market participants who utilize the act's netting provisions for contracts where parties agree to pay or receive the net payment, rather than the gross amount.

About Regulation EE

Regulation EE, introduced in the early 1990s, enables banks, investment brokers, and clearing organizations to settle mutual obligations at their net value, known as contractual netting. This offsets multiple positions or payments due between parties, simplifying transactions.

The Federal Reserve's primary aim in expanding the definition of financial institutions was to enhance efficiency and reduce systemic risk in the financial markets. This expansion, which occurred in 2019 and 2021, included the addition of swap dealers, security-based swap dealers, swap participants, security-based swap participants, nonbank systematically important financial institutions, and certain financial market utilities.

Regulation EE vs. Regulation E

Regulation EE defines "financial institution" for netting agreements, while Regulation E is a federal rule that oversees electronic fund transfers. Reg. E establishes guidelines for debit card issuers and sellers and safeguards consumers against electronic funds fraud.

Qualifying as a Financial Institution

If a person qualifies as a financial institution under paragraph (a), they are considered a financial institution for any contract entered into during that period, even if they later fail to qualify. To qualify as a financial institution under sections 401-407 of the act, a person or institution must meet the following criteria:

1. They must represent, orally or in writing, that they will engage in financial contracts as a counter-party on both sides of one or more financial markets.
2. They should have one of the following:
   1. One or more financial contracts with a total gross dollar value of at least $1 billion in notional principal amount outstanding on any day during the previous 15-month period with non-affiliated counterparties.
   2. Total gross mark-to-market positions of at least $100 million (aggregated across counterparties) in one or more financial contracts on any day during the previous 15-month period with non-affiliated counterparties.

In February 2021, the Federal Reserve expanded the definition of "financial institution" under Regulation EE. This expansion included swap dealers, foreign banks, central banks, and certain non-bank entities considered systematically important to the financial sector.

Goals and Impact of Regulation EE

Regulation EE's primary objective was to expand the definition of "financial institution" to encompass systemically important market participants involved in financial contracts. It applies to various entities classified as "financial institutions," governing the netting of swaps and other OTC derivatives or contracts. Netting involves offsetting the value of multiple positions or payments between parties.

Conclusion

Regulation EE broadens the definition of "financial institution" to include more entities in the financial markets. Its primary aim is to enhance efficiency and reduce systemic risk. By enabling banks, investment brokers, and clearing organizations to settle mutual obligations at their net value, this regulation simplifies transactions and promotes a more stable financial system.