29th October 2014
For More Information please contact
Vincent Keaveny Partner – Structured
Farid Anvari Of Counsel – Structured
Finance/Derivatives +44 207 919 1564
ISDA Resolution Stay Protocol
In pursuit of certainty
Since the financial crisis the development of an international
framework to resolve cross-border financial institutions and groups
has been a priority of regulators. One of the key issues that
regulators have focused upon as having the potential to disrupt
smooth resolution of systemically important financial institutions
("SIFIs") has been the close-out and cross-default rights of parties
to OTC derivative contracts which are triggered by a SIFI’s
financial distress or entry into resolution proceedings. In
November 2013 regulators from six jurisdictions (France,
Germany, Japan, Switzerland, the United Kingdom and the United
States of America) asked ISDA to amend its Master Agreement to
eliminate close-out rights against SIFIs triggered by resolution
action against a SIFI. ISDA set up a working group with
representatives from the sell-side and buy-side working with
regulators and is close to finalising the ISDA Resolution Stay
Protocol (the "Protocol") to allow parties to make bilateral
amendments to their ISDA Master Agreements to facilitate special
resolution regimes around the globe. It is the latest in a long line of
ISDA initiatives to help market participants comply with new
regulations applicable to the OTC derivatives market. The Protocol
is due to be published in the next couple of weeks and we
understand that eighteen SIFIs and certain affiliates will be
adhering. It is only matter of time before the wider market will also
be forced to consider these issues.
Implications for non-SIFIs
While eighteen SIFIs and certain of their affiliates are expected to
adhere to the Protocol before the G20 meeting in Brisbane in
November 20141 other entities trading derivatives are also likely to
find themselves impacted by the Protocol. It is likely that the SIFIs
and other entities that adhere to the Protocol will wish to have all
their counterparties amend their ISDA Master Agreements in line
with the Protocol amendment. Such entities, and their regulators,
1 At the St. Petersburg G20 Summit in 2013 the Financial Stability Board made a commitment to "develop policy proposals on how legal certainty in
cross-border resolution can be further enhanced" by the time of the Brisbane Summit in November 2014. The FSB favours effective statutory crossborder
recognition processes; however its view is that until comprehensive statutory regimes have been adopted in all relevant jurisdictions, contractual
arrangements could offer a workable interim solution. The ISDA Protocol is one such contractual arrangement.
are likely to reach out to SIFIs' trading counterparties and ask them to adhere to the Protocol on a voluntary basis. If counterparties do not agree voluntarily to amend their ISDA Master Agreements to facilitate resolution regimes applicable to SIFIs, then regulation to ensure consistent cross border approaches on this issue is expected in 2015 with effectiveness in 2016 or 2017. Background to the Protocol / What the Protocol does Since the financial crisis the development of an international framework to resolve cross-border financial institutions and groups has been a priority of regulators. A significant milestone was the adoption in 2011 of a non-binding international standard by the Financial Stability Board ("FSB") in its Key Attributes of Effective Resolution Regimes for Financial Institutions 2(the "Key Attributes"). The Key Attributes specify essential features that should be part of the resolution framework with the key objectives of making resolution feasible without severe systemic disruption and without exposing taxpayers to loss. These features include a comprehensive “toolkit” of resolution powers for national authorities, including powers to support the resolution through a temporary stay on the execution of early termination rights under financial contracts. Typically such temporary stays are between 24 to 48 hours. A number of jurisdictions have developed special resolution regimes ("SRRs"). In The EU this has been effected by the Bank Recovery and Resolution Directive ("BRRD")3 which is due to be implemented in national Member States by 1 January 2015. The SRRs generally stay or override the exercise of direct defaults and cross defaults that arise due to a resolution, provided that certain creditor protections are satisfied. Some SRRs, BRRD included, provide for recognition and enforcement of third country resolution proceedings. However this is not always the case and in some jurisdictions such recognition and enforcement is discretionary. This leads to a potential gap whereby foreign counterparties to an entity in resolution may not be subject to the same stays or overrides as its domestic counterparties. It is this gap that the Protocol is seeking to fix by way of a bilateral contractual
2 Financial Stability Board - Key Attributes 2011 http://www.financialstabilityboard.org/publications/r_111104cc.pdf The Key Attributes specify essential features that should be part of the resolution framework at both the national and international levels, with the key objective of making resolution feasible without severe systemic disruption and without exposing taxpayers to loss. These features include a comprehensive “toolkit” of resolution powers for national authorities, including powers to: (i) assume control of a financial institution from existing managers and owners; (ii) effect a resolution of the troubled institution through the sale or merger of the entity, the transfer of assets and liabilities of the institution to third parties, or through unilateral debt restructuring or “bail-in”; and (iii) support the resolution through a temporary stay on the execution of early termination rights under financial contracts. The Key Attributes foster effective international cooperation. They call for national resolution frameworks to be designed in a manner that enables and encourages the resolution authorities to cooperate with their foreign counterparts in a cross-border resolution.
The Key Attributes specify that "The statutory mandate of a resolution authority should empower and strongly encourage the authority wherever possible to act to achieve a cooperative solution with foreign resolution authorities." BRRD contains such a requirement.
Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of the European Parliament and of the Council
amendment between the two parties to the ISDA Master Agreement. The Protocol allows adhering parties to agree to "opt in" to the resolution regime applicable to their counterparty, if the counterparty or related entity becomes subject to proceedings under certain resolution regimes4. It aims to ensure that the ability of a non-defaulting party to terminate the ISDA Master Agreement (or suspend performance or prevent transfer) will be the same as if the contract had been governed by the law of the SIFI's home jurisdiction i.e. subject to the SRR provisions whatever they are. For example without such an amendment a foreign counterparty might choose to terminate its ISDA Master Agreement, or withhold performance under it, and put the SIFI's resolution authority to the trouble of litigating albeit it with a high likelihood of success given cross border recognition. The amendment to be included in the Protocol will attempt to fix this gap. In due course global regulators will seek to fix this gap by regulation5, however in the meantime global SIFIs and certain subsidiaries will be amending their ISDA Master Agreements so that their counterparties opt in to the SRR of their jurisdiction. Actions to consider As a derivatives market participant you need to be aware of the moves afoot globally to facilitate the resolution of systemically important financial institutions. You need to be aware that regulation is coming to encourage all market participants to amend their OTC derivatives master agreements to allow for stays of termination rights and override cross default provisions in the event of a resolution proceeding applying to its SIFI counterparties. You should note that: • Swap counterparties may contact you to ask you to adhere to the Protocol or to otherwise bilaterally amend your ISDA Master Agreements. • You need to analyse whether you wish to adhere to the Protocol voluntarily to ensure that the trading lines with large financial institutions are not affected or you prefer to wait for regulation to impose this change. • You may wish to conduct an analysis of the protections, if any, you may be giving up by agreeing to the amendments. Conclusion The ISDA Protocol does not contain provisions dealing with resolution regimes it merely seeks to extend the application of applicable resolution regimes to cross border activities in an
4 Covered regimes (i) Existing resolution regimes in France, Germany, Japan, Switzerland, UK, US and (ii) newly-created regimes in other FSB jurisdictions, provided they meet the requirements under the Protocol, namely Argentina, Australia, Brazil, Canada, China, Hong Kong, India, Indonesia, Italy, Mexico, Netherlands, Republic of Korea, Russia, Saudi Arabia, Singapore, South Africa, Spain, Turkey.
5 FSB Consultation Cross-border recognition of resolution action
On 29th September 2014 the FSB issued a consultation on Cross-border recognition of resolution action. It included supporting and promoting contractual approaches to cross-border recognition pending widespread adoption of comprehensive statutory frameworks.
attempt to create a level playing field for domestic and cross border counterparties of SIFIs. Once the market becomes more familiar with these resolution regimes and the ways in which they already restrict non defaulting parties' rights against such entities in resolution it may be that the initial negative reaction to giving up these important termination rights will be less forceful. In many cases it is likely that the same outcome would apply whether parties amend or do not amend their ISDAs. A major point in favour of adhering to the Protocol is to create certainty of outcome. Markets in general, and the derivatives markets in particular, hate uncertainty. Cross border recognition of regimes is at present anything but certain. The Protocol allows parties to contractually agree which provisions of resolution regimes would apply to their trading relationships and that can only be a good thing. Perhaps it is better to give up a perceived right (to terminate, withhold performance or prevent transfer) and to gain certainty of outcome than to hold on to the right to dispute such matters when its large SIFI counterparty gets into difficulties. Until regulators force parties hands it is a judgment call for each market participant to make. Baker & McKenzie Derivatives Practice - London Baker & McKenzie is one of the world's leading international derivatives practices and we have developed a vast wealth of experience and talent around the world which we harness to provide an unparalleled global service to our clients. Our approach is to provide practical, professional and cost-effective advice. We act for a diverse client base including corporate end-users both multinational and domestic, investment and commercial banks, governmental and supranational entities, insurance companies, funds and investors. Our wide client base gives us a unique view of all aspects of the global derivatives market. We advise on the full range of derivative products from OTC derivatives and exchange traded products to debt capital markets instruments and securitisation structures.
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