ISDA introduces protocol to address upcoming rules related to qualified financial contracts in the orderly resolution of systemically important financial institutions

U.S. federal banking regulations that go into effect next year require certain major financial institutions to ensure that their qualified financial contracts (QFCs), such as swaps and repurchase agreements, are subject to temporary or permanent limitations on counterparties' legal abilities to exercise default rights in the event that the financial institution becomes subject to a resolution regime as a result of financial distress, such as that which may result from capital or liquidity problems. Many QFCs contain termination rights that are triggered upon the insolvency of a counterparty or an affiliate of a counterparty. These rights are ordinarily not subject to the U.S. Bankruptcy Code's automatic stay on proceedings against a debtor and are ordinarily not affected by the appointment of the Federal Deposit Insurance Corporation as receiver of an insured depository institution.

In lieu of requiring each QFC to be amended on a bilateral basis to comply with the new federal regulations, covered financial institutions are allowed a regulatory "safe harbor," allowing counterparties to QFCs to adhere to a uniform protocol that would have the effect of amending each QFC. The federal regulations were issued by the prudential banking regulators, namely the Board of Governors of the Federal Reserve System (the Fed), the Federal Deposit Insurance Corporation (the FDIC), and the Office of the Comptroller of the Currency (the OCC, and together with the Fed and the FDIC, the Prudential Regulators) and are substantively similar to each other, with certain differences to account for the nature of the regulated institutions. The protocol would override QFC participants’ usual contractual rights to exercise default rights as a result of a bankruptcy or insolvency event and would also override the exceptions to the U.S. Bankruptcy Code’s and Federal Deposit Insurance Act's automatic stays. Although the federal statutes governing resolution regimes have such override provisions, the protocol would constitute an express contractual consent to the overrides. This summer, the International Swaps and Derivatives Association (ISDA) introduced the ISDA 2018 U.S. Resolution Stay Protocol (the U.S. Stay Protocol), and market participants have commenced the adherence process. In the coming months, swap participants, including funds and commercial end users, may be asked by their bank counterparties to adhere to this protocol via the ISDA website.

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