By David Geen and Samantha Riley of the International Swaps and Derivatives Association (ISDA)
The International Swaps and Derivatives Association (“ISDA”) recently published the 2014 Resolution Stay Protocol (the “Protocol”). Developed by a working group comprised of both dealer and buy-side market participants in consultation with regulators from France, Germany, Switzerland, Japan, the United Kingdom and the United States, the Protocol has been hailed by the Financial Stability Board as a “crucial element of the policy framework to end too-big-to-fail.” In addition to addressing the failure of systemically important financial institutions (“SIFIs”) under special resolution regimes, such as the Orderly Liquidation Authority provisions of the Dodd-Frank Act or the EU Bank Recovery and Resolution Directive, Section 2 of the Protocol also addresses the failure of SIFIs under the U.S. Bankruptcy Code (the “Code”).
Section 2 of the Protocol was developed to support SIFI resolution strategies under the Code where operating companies, such as banks and broker dealers, are kept out of insolvency proceedings altogether, while affiliates, such as a parent holding company, are restructured through Chapter 11 proceedings. Section 2 introduces a short, temporary stay on the exercise of default rights that arise because of the parent’s or other affiliate’s entry into bankruptcy proceedings to enable the SIFI to take actions to preserve the operating companies as going concerns. If the actions taken satisfy the conditions established by the Protocol, the termination rights that arose as a result of the SIFI entering bankruptcy proceedings would be permanently overridden.
Naturally, questions have arisen as to the interplay between Section 2 of the Protocol and the safe harbors for swap agreements under the Code. The Code stays, and safe harbors, default rights that arise because a counterparty to an ISDA Master Agreement subject to the Protocol enters proceedings under the Code; it does not stay (and therefore does not need to safe harbor) contracts between non-debtor affiliates and their counterparties. The Protocol only addresses the affiliate contracts, and thus does not alter the scope or application of the safe harbors.