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Devil in the Detail: FSB Eyes Extension of Contractual Stays for G-SIIs?

On 3 November 2015, the Financial Stability Board (FSB) published a consultation paper on “Developing Effective Resolution Strategies and Plans for Systemically Important Insurers”.

The consultation paper develops themes first documented in the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” (the “Key Attributes”).  Amongst other things, it discusses the way in which stays of early termination rights may be used to support the use of resolution tools and to help achieve financial stability and policyholder protection objectives.

The consultation paper recognises that any exercise of the power to stay early termination rights must be exercised in accordance with the Key Attributes.  Key Attribute 4 states that entry into resolution and the exercise of any resolution power should not constitute an event that entitles a counterparty of the firm in resolution to exercise early termination rights provided the substantive obligations under the contract (e.g. payment and delivery obligations and provision of collateral) continue to be performed.  Resolution authorities should have the power to stay early termination rights only where they arise by reason of entry into resolution or in connection with the exercise of any resolution powers, and even then subject to certain limitations and safeguards.

The need to impose a stay on the early termination of derivatives transactions entered into by an insurer in resolution so as to facilitate the transfer of derivatives portfolios to a bridge entity or a third party acquirer is given by way of example.  This element has already been well documented in the context of bank resolution and is clearly in-scope and necessary.  However, also discussed within the consultation paper – but less clearly in-scope – is the possibility of enforcing a contractual stay on other contractual rights, such as the ‘cashing-out’ of annuities.

One would assume that, broadly, an annuity can be ‘cashed-out’ at any time (subject to the giving of notice and the application of a haircut on amounts returned).  Granted, ‘cashing-out’ an annuity has the effect of terminating the relationship between the parties and results in a net outflow of cash from the insurer in resolution.  To that extent, ‘cashing-out’ rights do have the ‘look and feel’ of an early termination provisions.  Nonetheless, can this rightly be regarded as an example of a termination right which ‘arises by reason of entry into resolution’ (and therefore something which should be subject to contractual stays) or is it nothing more than an example of a simple contractual right?  If this is not an early termination provision, does this constitute an (unwelcome) extension of regulatory powers to stay contractual rights?  Conversely, if it is an example of an early termination provision, are G-SIIs faced with the prospect that they will have to amend all of their annuity contracts in order to include contractual stay provisions?  In the context of bank resolution, we have already seen the efforts by industry bodies such as ISDA to tackle – by way of protocol – the documentation challenge created by the requirement to impose contractual stays.  However, enforcing contractual stays against (presumably) a retail population is a challenge of a completely different nature, potentially on a scale far greater than that faced by banks in amending their financial contracts.  It raises questions as to whether protocol-based approaches would be effective and, if not, where the resources to execute this kind of industry-wide amendment effort would be found.  The consultation period closes on 4 January 2016 and national-level regulation is some way down the track.  As such, it may be some time before we understand the true implications, but at least the market will have a chance to make its views known.

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