Global Banks Rewrite Contracts in Bid to Avert Lehman Repeat

  • Wells Fargo, UniCredit and ING join adherents to protocol
  • New agreement applies to securities financing transactions

The world’s biggest banks agreed to rewrite trillions of dollars of financial contracts as the industry responds to pressure from regulators to help make sure lenders can fail without bringing down the global economy.

The contracts help lubricate the workings of the global financial system, governing securities financing transactions and derivatives trades. The new protocol, drawn up by the International Swaps and Derivatives Association and three other industry groups, will allow agreements between the signatory banks to remain intact for a period after a bank fails, ISDA said in a statement on Thursday.

The goal is to prevent a recurrence of the messy bankruptcy of Lehman Brothers Holdings Inc. in 2008, which helped trigger a global economic slump. The protocol will complement regulators’ efforts to solve the problem of too-big-to-fail banks, including the total loss-absorbing capacity rules announced by the Financial Stability Board this week. Group of 20 leaders are set to endorse the TLAC rules at a summit next week.

“This is all about too-big-to-fail and systemic risk,” said Doug Shaw, a capital markets lawyer at Linklaters LLP in London. “The protocol involves giving up existing rights, so entities signing up actually don’t get very much in return if they’re facing a counterparty that might enter into resolution. It’s a bit of a one-way street.”

Resolution Regimes

The signatories to the revised protocol agreed to abide by the provisions of home-country resolution regimes should a counterparty have to be wound down. Lehman’s collapse was accelerated and the costs of the failure increased as counterparties ended securities financing and lending transactions early, along with derivative deals, and seized collateral backing the contracts.

The extension of the protocol to securities financing transactions by the global banks means that “more than $560 billion of cross-border securities-financing activity that could previously have been terminated at the point of resolution will be subject to the stay regimes” of firms’ home jurisdictions, the FSB said.

Some derivative contracts were covered by a protocol signed in November last year, which is replaced by the new one, Shaw said. The new one covers 21 banks, including new entrants Wells Fargo & Co., UniCredit SpA and ING Bank NV, compared with 18 signatories to the previous agreement.

‘Wider Universe’

The new protocol “captures a wider universe of financial contracts, further reducing the risk that a bank resolution triggers a chaotic unwind of financial contracts,” ISDA Chief Executive Officer Scott O’Malia said in a statement. The aim is “to meet the regulatory objective of broadening contractual stays to support cross-border resolution and strengthen systemic stability.”

ISDA worked with the International Capital Market Association, the International Securities Lending Association, and the Securities Industry and Financial Markets Association to develop the requirements for securities financing transactions, according to the statement.

The U.K.’s Prudential Regulation Authority is among supervisors that are planning to introduce their own requirement that contracts have stays written into them, irrespective of the nature of the counterparty’s business. The rules it’s planning only cover early termination of contracts, said Shaw.

The protocol “is basically an FSB initiative, part of its push to ensure bank resolution can be made effective,” Shaw said.

Bank of England Governor Mark Carney, who heads the FSB, said the financial crisis “exposed critical obstacles to cross-border resolution that complicated authorities’ ability to stem contagion across the global financial system.” The new protocol “closes off much of the cross-border close-out risk that statutory stays have not been able to eliminate because their reach is limited to national borders,” he said.

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