On October 11, 2014, the International Swaps and Derivatives Association (ISDA) announced that its newly developed resolution stay protocol would be adopted by 18 of the biggest banking organizations in the world. The Federal Reserve Board and the FDIC quickly issued a relatively rare Saturday press release lauding the new protocol and the agreement by those banks to sign it.

The new protocol imposes a stay on the cross-default and early termination rights contained in standard ISDA derivatives contracts between the signatories to the protocol. This stay will give regulators time to resolve a troubled institution in a manner less likely to provoke systemic risk.

When a business goes into bankruptcy, there usually is a stay that goes into place on any actions pending or to be brought against the failed institution. Derivatives transactions usually are exempt from such stays so the nondefaulting party will move quickly to liquidate collateral in order to satisfy the defaulting party’s obligations.

ISDA develops master agreements used by much of the industry engaging in over-the-counter swaps and derivatives transactions. These master agreements usually provide for early termination and cross default rights in the event of the default of its counterparty. However, in the event that the defaulting party is a regulated financial institution, these provisions can interfere with the ability of the regulator to resolve the troubled institution in a more orderly manner and avoid the chaos that could result in numerous parties moving quickly to secure assets.

The protocol was developed in consultation with the Financial Stability Board, an organization that coordinates at the international level the work of national financial authorities and  international standards setting organizations, which discussed the concept in its recently issued consultation paper on cross-border resolutions. Banking regulators from the world’s largest economies have committed to incorporating the concept behind the protocol into their laws and regulations.

The protocol will become effective January 1, 2015, although the signatories will begin voluntarily to comply beginning next month.

Read the ISDA press release and the Federal Reserve Board-FDIC joint press release.

In addition, there is a recent blog post on the Financial Stability Board’s consultation paper posted in the UK and EU region of the Financial institutions: Regulation tomorrow blog.