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From Securities Regulation Daily, October 14, 2014

Global banks agree to a stay on derivatives contract rights during resolution

By Jim Hamilton, J.D., LL.M.

In a move hailed by central banks and securities regulators, 18 globally significant financial institutions agreed to a stay on cross-default and early termination rights within standard derivatives contracts in the event one of them is subject to resolution action in its jurisdiction. Counterparties have agreed to the cross-border enforceability of temporary stays on early termination and cross-default rights in over-the-counter (OTC) bilateral derivatives contracts. The stay is intended to give regulators time to facilitate an orderly resolution of a troubled financial firm.

The U.S. securities industry strongly supported the agreement to delay the termination of derivatives contracts in the event of the resolution of a related troubled financial institution. In a statement, SIFMA said that implementation of the agreement will allow financial firms to better manage systemic risk. SIFMA added that both its sell-side and buy-side members have been highly engaged in this important industry initiative.

The agreement was vetted by the International Swaps and Derivatives Association (ISDA), and the financial institutions agreed to sign a new ISDA Resolution Stay Protocol, developed in coordination with the Financial Stability Board to support cross-border resolution and reduce systemic risk. This action represents a major step in strengthening systemic financial stability. ISDA CEO, and former CFTC Commissioner, Scott O’Malia, declared that this initiative will also address the too-big-to-fail issue and reduce systemic risk, while simultaneously incorporating important creditor safeguards.

By adhering to the agreement, the firms will extend the coverage of stays to more than 90 percent of their outstanding derivatives notional, and that proportion will increase as other firms sign up. The agreement will take effect on January 1, 2015, and will govern both new and existing trades between adhering parties.

FSB Chair, and Bank of England Governor, Mark Carney hailed the agreement as an important step towards ending too big to fail. He noted that the agreement will close off much of the cross-border close-out risk that statutory stays have not been able to eliminate because their reach is limited to national borders.

Specifically, the agreement enables counterparties to opt into certain overseas resolution regimes via a change to their derivatives contracts. While many existing national resolution frameworks impose stays on early termination rights following the start of resolution proceedings, these stays might only apply to domestic counterparties trading under domestic law agreements and thus might not capture cross-border trades.

For their part, regulators have committed to develop new regulations in their jurisdictions in 2015 that will promote broader adoption of the stay provisions beyond the 18 global financial institutions that have, in turn, committed to expand coverage once such regulations are enacted to include a stay that could be used when a U.S. financial holding company becomes subject to proceedings under the U.S. Bankruptcy Code.

The contractual approach is meant to support current statutory regimes and ensure wider, more consistent application.

The German Federal Financial Supervisory Authority (BaFin) welcomed the agreement as a major step in handling derivatives and solving the too-big-to-fail problem. BaFin President Dr. Elke König stated that the agreement represents a major contribution to the stability of global financial markets. She pledged to adopt regulations implementing the agreement.

The Fed and the FDIC said that the agreement is an important step toward mitigating the financial stability risks associated with the early termination of bilateral, OTC derivatives contracts triggered by the failure of a global banking firm with significant cross-border derivatives activities.

The federal banking agencies understand the resolution stay provisions to facilitate an orderly resolution of a major global banking firm by giving the bankruptcy court or resolution authority the ability to prevent early termination of derivatives contracts of the firm's global subsidiaries.

MainStory: TopStory Derivatives ExchangesMarketRegulation InternationalNews

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