The Federal Deposit Insurance Corporation (FDIC), together with the Bank of England, the German Federal Financial Supervisory Authority (BaFin), and the Swiss Financial Market Supervisory Authority (FINMA), have authored a joint letter to encourage the International Swaps and Derivatives Association, Inc (ISDA) to 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 (G-SIFI).
The adoption of the proposed changes would allow derivatives contracts to remain in effect throughout the resolution process following the implementation of a number of potential resolution strategies. By minimising the disorderly unwinding of such contracts, these changes would place resolution authorities in a better position to resolve G-SIFIs in a manner that promotes financial stability while providing market certainty and transparency.
"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 harmonise 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 minimise moral hazard in the event of a G-SIFI resolution."
Press release
Full letter
ISDA response
Responding to the letter in a statement on 6 November, ISDA said: “ISDA supports efforts to create a more robust financial system and reduce systemic risk. Toward that end, we have, over the course of 2013, discussed with policymakers and OTC derivatives market participants issues related to the early termination of OTC derivatives contracts following the commencement of an insolvency or resolution action. We have developed and shared papers that explore several alternatives for achieving a suspension of early termination rights in such situations.
"One of those alternatives, which is supported by a number of key global policymakers and regulatory authorities, would be to amend ISDA derivatives documentation to include a standard provision in which counterparties agree to a short-term suspension. Developing such a provision that could be used by counterparties will continue to be a primary focus of our efforts in this important area of regulatory reform. We are committed to working with supervisors and regulators around the world to achieve an appropriate solution that will contribute to safe, efficient markets.”
Press release
Commenting on the ISDA's statement, Regulatory Reform posted the following on their blog:
This development comes shortly before other anticipated amendments to the ISDA Master Agreement. Specifically, in the near future, ISDA is expected to publish recommended amendments to Section 2(a)(iii) – a clause which broadly states that the fulfilment by a party of its obligations towards its counterparty are subject to the condition precedent that no event of default has occurred with respect to the counterparty. Whilst the details of this amendment are not absolutely clear at this stage, it currently seems that the ability of a party to withhold performance following the occurrence of an event of default affecting its counterparty in accordance with Section 2(a)(iii) will be limited in time to 90 days.
Whether ISDA intends to assist market participants in their repapering efforts by way of a protocol is as yet unknown. Either way, in light of the on-going derivative documentation amendment programmes triggered by Dodd-Frank and EMIR, the present seems like a good time to start factoring these additional requirements into future client outreach schedules.
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