Six trade associations representing non-dealer swap market participants sent a letter to the Financial Stability Board on November 4, urging the FSB to reconsider its initiative to promote contractual waivers of default rights under industry-standard derivative master agreements. The letter, signed by the Managed Funds Association, the Alternative Investment Management Association Limited, the American Council of Life Insurers, the Association of Institutional Investors, the Commodity Customer Coalition and the Commodity Markets Council, responds to comments made by the FSB in the consultative document entitled “Cross-Border Recognition of Resolution Action” published on September 29 (click here for access). In this publication, FSB identified many difficulties that currently prevent optimal cross border coordination in the winding up of a global systemically important financial institution and endorsed the use of contractual approaches to achieve cross-border compliance with relevant insolvency laws. This kind of contractual approach was incorporated in the recently announced Resolution Stay Protocol of the International Swaps and Derivatives Association where, after implementation, 18 leading global banks will agree to postpone their right to immediately terminate bilateral non-cleared swap transactions in the case of the insolvency of another adhering counterparty. The trade associations argued that such policy objectives are better pursued by traditional legislative means rather than by indirect coercion of swap end users. (Click here to see more information in the article “ISDA Announces Stay Agreement for Banks Too Big to Fail” in the October 6 to 10 and 13, 2014 edition of Bridging the Week.)
Guest Commentary: The letter to the FSB identifies some legitimate causes for concern about a relatively new tactic being used by regulators to manage systemic risk arising from derivatives. This technique involves requiring or persuading entities they regulate to force counterparties they do not regulate to accept contractual limits on their rights to terminate swaps following the insolvency of a financial institution. Promoting the orderly unwinding of financial institutions is certainly a desirable goal, but this tactic inevitably raises questions about the extent to which the ends justify the means. The trade associations make the fair point that, from both a policy and a process perspective, use of this tactic may lead to a sub-optimal outcome compared to achieving the desired goal through changes in insolvency laws.