26 May 2015

Bank of England: Contractual stays in financial contracts governed by third-country law

A key aspect of effective resolution is ensuring that, once a firm enters resolution, its counterparties in derivatives and other financial contracts (such as repo/reverse repo, securities lending and other similar transactions subject to contractual set-off and netting arrangements) cannot terminate and ‘close out’ their positions solely as a result of the firm’s (or a related entity’s) entry into resolution.

The Banking Act 2009 (Banking Act) gives the Bank of England, as resolution authority, the power to suspend (or ‘stay’) temporarily the termination rights of a party to a contract with a firm in resolution, provided that the UK institution continues to perform its payment and other substantive obligations under the contract (the temporary stay).   It further provides that a resolution action (or pre-resolution action) by the Bank of England, the Prudential Regulation Authority (PRA) or the Financial Conduct Authority (FCA) cannot give rise to a counterparty’s right to terminate a contract with a UK credit institution or investment firm or to exercise rights over collateral (the general stay).

The Bank Recovery and Resolution Directive (Directive 2014/59/EU) (BRRD) ensures that a UK stay would automatically be recognised and given effect throughout the European Union (EU).  Where a contract is governed by the law of a non-EU jurisdiction, however, it is unclear that a court in that jurisdiction would enforce the UK stay over the contractual terms unless the law of that jurisdiction expressly recognises foreign resolution actions.

The proposal is part of a coordinated effort among member authorities of the Financial Stability Board (FSB) to improve cross-border recognition of resolution stays by obliging firms to adopt contractual solutions where statutory recognition regimes are lacking.

The proposed rule would apply to UK banks, building societies and designated investment firms as well as their qualifying parent undertakings (‘firms’) in respect of financial contracts (such as for derivative, repo/reverse repo or securities financing transactions) governed by the law of a non-EEA jurisdiction.  It would prohibit firms from creating new obligations or materially amending an existing obligation under such a financial contract without the required counterparty agreement.  The prohibition applies unless the counterparty has agreed in writing to be subject to similar restrictions on termination, acceleration, close-out, set-off and netting as would apply as a result of the firm’s entry into resolution, or the write-down or conversion of the firm’s regulatory capital at the point of non-viability, if the contract were governed by the laws of the UK (and, where the relevant firm is not a credit institution or investment firm, as if it were one).

Firms would also be obliged to ensure that, where their subsidiary credit institutions, investment firms and financial institutions trade in these products under third-country law, the subsidiaries, regardless of location, also obtain agreement to the stay from their counterparties.

This consultation closes on Wednesday 26 August 2015.

Full information

Consultation paper

© Bank of England