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ISDA early termination to be suspended

On 6 August 2014, 11 US banks received a reminder by their regulators that the rights on early termination in their ISDA Master Agreements will require material changes in order to provide credibility for their living wills. This comment likely applies to every institution which is required to produce a living will under the Dodd-Frank Act, since the wording of the ISDA Master Agreement on early termination is generally standard.

Background information on suspension of termination right

The turning point on this issue came in October 2011. The Financial Stability Board (FSB) noted in its report on Key Attributes of Effective Resolution Regimes for Financial Institutions  that in the case of Systemically Important Financial Institutions (SIFIs), the termination of large volumes of financial contracts upon entry into resolution can result in significant market instability and prevent the regulators from ensuring continuity for the SIFIs

On 5 November 2013, Martin Gruenberg, the Chairman of the US FDIC, together with Mark Carney, the Governor of the Bank of England, Dr. Elke König, the President of BaFin, and Patrick Raaflaub, the CEO of the Swiss Financial Market Supervisory Authority sent a letter to ISDA requesting specifically a short-term suspension of early termination rights. It is advanced in the letter that ISDA is in a unique position to allow for such a change in a consistent manner through contractual provisions.

The Federal Deposit Insurance Corporation (FDIC)  has been working with foreign resolution authority counterparts as well as the other U.S. banking agencies to encourage ISDA to develop a protocol that could be used for amending its standard documentation.

Challenge for ISDA

This request is likely to present important challenges for ISDA since it puts into question one of the historic purposes of the ISDA Master Agreement. Since its inception, ISDA has been promoting an approach where a non-defaulting counterparty could terminate and close-out very quickly its transactions with a counterparty that was triggering an event of default.

Tensions within the derivatives community on an eventual protocol should be expected. Such a drastic change might be in the interest of the SIFIs, but the other counterparties might fail to see what is in the protocol for them. Looking back at past ISDA protocols, even the less controversial ones could not be adopted unanimously by the derivatives community. ISDA has no legal power to force a “mandatory” protocol and it is not its usual role to wield the stick or the carrot.

Next step

ISDA is expected to present the protocol on time for the G20 Brisbane meeting in November 2014. In the US, the regulators expect to see revised living wills by 1 July 2015, addressing the issue of suspension of termination rights.

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