Fitch said the move by banks “comprising the world’s largest swap dealers” curbs swap termination rights for counterparties of foreign-based bank subsidiaries when the subsidiaries' parent is subject to an insolvency or resolution in its home jurisdiction.
The chief executive officer of the International Swaps and Derivatives Association Inc (ISDA), Scott O’Malia, said: “This is a major industry initiative to address the too-big-to-fail issue and reduce systemic risk, while also incorporating important creditor safeguards. The ISDA resolution stay protocol has been developed in close coordination with regulators to facilitate cross-border resolution efforts and reduce the risk of a disorderly unwind of derivatives portfolios.”
Fitch said the resolution stay is a voluntary step that “overcomes prudential regulators’ concerns about their abilities to extend already-mandatory stays” under Title II of the US Dodd-Frank Act (848-page / 1.75 MB PDF) and the EU Bank Recovery and Resolution Directive.
“By adopting the protocol, the 18 banks allow a period of time for regulators to assess and potentially oversee the transfer of contracts following a resolution, a potentially far more orderly outcome than seen following the default of Lehman Brothers in 2008, where swap terminations and the capital calls they generated ultimately collapsed the firm,” Fitch said.
However, Fitch said “many important issues remain unresolved... workable resolution plans have further to progress, much less be actually tested under the conditions of a wide-spread market disruption”. “While swap stays provide incremental time to assess a crisis situation, it is unclear if the time allotted would be sufficient.”
According to Fitch, the move is “a further step toward enabling practical resolutions of systemically important banks”. “These steps not only improve the chances for a future resolution’s success, but also chip away at what US banking regulators have called “unworkable” resolution plans put forth by banks.”
Fitch said shortcomings in banks’ ‘living wills’, identified in August 2014 by the US Federal Reserve and other institutions, “included optimistic and unrealistic assumptions, reliance on unsupported expectations regarding the international resolution process, and failures to address structural and organisational impediments to an orderly resolution of the firm in bankruptcy”.
The stay protocol applies to each of the banks' master swaps agreements and is expected to be formally enacted at a meeting of the G20 group of nations in Brisbane, Australia, in November 2014, Fitch said.