FSB backs derivatives crisis-clause

Global regulators have backed a plan by the global derivatives industry to allow authorities more time to decide on a resolution plan if a bank gets into financial difficulty.

The Financial Stability Board on Monday accepted a proposal overseen by the International Swaps and Derivatives Association, an industry trade body, to insert a so-called “stay” on the bank’s derivatives contracts, which are frequently worth billions of dollars in notional value.

The agreement comes as the FSB, a co-ordinating body for the G20 economies, looks to resolve some of the biggest outstanding issues relating to “too big to fail” institutions this year. Mark Carney, chairman of the FSB, wanted an agreement on bailing in creditors of globally significant, cross-border banks that get into trouble before November’s G20 meeting in Brisbane, Australia.

Over-the-counter derivatives are particularly complex as they are frequently conducted across borders and do not have a single domicile where they are ultimately registered.

Regulators had been concerned by potential chaos if a counterparty exercised its right to close out their swaps in those crucial hours after a central bank rule.

Positions in the bank that had been hedged using derivatives could become unhedged and plunge the institution into default and markets into further chaos – a problem illustrated by the failure of Lehman Brothers in 2008.

The FSB has asked that these swap contracts legally “stay alive” for a couple of days while authorities assess their options for a stricken bank and potentially transfer open positions to another bank.

Isda, which represents many of the world’s biggest users and broker-dealers, will begin a two-stage update of its master agreements, the legal framework on which trillions of dollars of derivatives deals are based.

Around 15 of the world’s largest banks are set to sign up in coming weeks and Isda expects the world’s largest institutional investors to participate from next year.

“We expect that a number of such banks will adopt the stay within new and existing contracts via a protocol this year. That protocol should be finalised within the next few weeks,” said a spokesman for Isda.

The FSB’s work aims to standardise an approach across the world. Some jurisdictions currently have no rules in place.

“Any contractual solution binds only the parties that agree to it. In order to be effective, such contractual provisions would have to be adopted by both sides of the trade,” the FSB said in a statement.

At an Isda conference in London last week Stephen O’Connor, chairman of Isda, estimated that most of the industry would be covered by the protocol.

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