Wednesday, November 27, 2013

Global Bank Supervisors Call for Uniform Derivatives Contract Language

Author: David Schwartz J.D. CPA

In a joint letter issued on November 5th, the FDIC, Bank of England, German Federal Financial Supervisory Authority, and Swiss Financial Market Supervisory Authority requested that the International Swaps and Derivatives Association adopt language in derivatives contracts to delay the early termination of those instruments in the event of the resolution of a global systemically important financial institution.

Specifically, the four resolution authorities are concerned with the cascading effects these derivatives contract termination rights and other remedies may have in the event of the insolvency of a major global counterparty.

We believe that it is essential for standard International Swaps and Derivatives Association (ISDA) documentation to provide for a short-term suspension of early termination rights and other remedies on the basis of the commencement of an insolvency or resolution proceeding or exercise of resolution power (e.g., transfer, appointment of a restructuring agent, etc.) with respect to a counterpart or its specified entity, guarantor, or credit support provider. Such a provision would allow, where the operative law permits, the exercise of all applicable types of resolution powers, especially the transfer of the derivative contracts and/or associated guarantee obligations to a third party, including a bridge entity, on an expedited basis, the bail-in of a failing institution through the write-down of liabilities, or the conversion of liabilities to equity.

"Uniform contractual language that limits termination rights with respect to derivatives transactions will greatly enhance the success of a resolution of a global systemically important financial institution (G-SIFI) which by its nature will have significant cross-border operations," said FDIC Chairman Martin J. Gruenberg. "The international regulatory community has worked closely to harmonize the statutory approach to this issue and our request to ISDA reinforces this effort. Continued efforts among international regulators to cooperate on cross-border resolution issues such as this will reduce the risk of global financial instability and minimize moral hazard in the event of a G-SIFI resolution."