Eighteen global banks have agreed to swaps contract changes designed to work with government rules for unwinding failed firms, a step that may help end the view that some financial companies are “too big to fail.”
Counterparties of banks involved in resolution proceedings will delay contract termination rights and collateral demands under the plan announced by the International Swaps and Derivatives Association. The change is intended to give regulators more time to arrange orderly resolutions, ISDA said in a statement released in Washington Oct. 11.
“This is a major industry initiative to address the too- big-to-fail issue and reduce systemic risk,” Scott O’Malia, ISDA’s chief executive officer, said in the statement. The agreement will “facilitate cross-border resolution efforts and reduce the risk of a disorderly wind-down,” he said.
ISDA, the main industry group for the $700 trillion global swaps market, changed the language in a new standard contract under pressure from U.S. regulators, according to three people with knowledge of the talks. The regulators had expressed concern that closeouts of derivatives transactions could hinder resolution efforts and roil markets, ISDA said.
The new protocols, which let banks opt into overseas resolution regimes that might otherwise apply only to domestic trades, initially will cover 18 major banks including JPMorgan Chase & Co., Goldman Sachs Group Inc., HSBC Holdings Plc and Credit Suisse Group AG. The agreement, set to take effect Jan. 1, extends coverage of the delays, or stays, to 90 percent of the outstanding notional value of derivatives, ISDA said.
Under U.S. bankruptcy law, derivatives including swaps are exempt from the stay that keeps creditors of a failed firm from immediately collecting what they’re owed. That means banks’ swap counterparties could move quickly to seize collateral.
Such a rush would make an orderly bankruptcy impossible, according to the Federal Reserve and Federal Deposit Insurance Corp., the agencies supervising the living-will plans banks must develop under the 2010 Dodd-Frank Act. In August, the regulators rejected plans from 11 of the largest U.S. and foreign banks, telling them to simplify their legal structures and address the bankruptcy exemption for swaps.
While any change in the bankruptcy code would need to be made by Congress, parties in swaps deals would have to abide by the terms of their private contracts.
Regulators have said a pause in the collection of swaps collateral could give a bank enough time to re-capitalize and avoid the kind of panic that followed the 2008 failure of Lehman Brothers Holdings Inc. They theorize that having a credible plan for unwinding failed banks would help end the perception by some market participants that governments will bail out firms that are too big to fail.
ISDA, backed by swaps dealers such as Goldman Sachs and JPMorgan, sets worldwide standards for derivatives — complex financial instruments whose value is tied to another asset, such as loans or stocks.
Other banks covered by the agreement are Bank of America Corp., Bank of Tokyo-Mitsubishi UFJ, Barclays Plc, BNP Paribas SA, Citigroup Inc., Credit Agricole SA, Deutsche Bank AG, Mizuho Financial Group Inc., Morgan Stanley, Nomura Holdings Inc., Royal Bank of Scotland Group Plc, Societe Generale SA, Sumitomo Mitsui Financial Group Inc. and UBS AG.
–With assistance from Silla Brush and Jesse Hamilton in Washington.
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